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wants
you to know about Interest Only Loans
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Interest
only loans have been misrepresented by many lenders. |
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Misperception
1:
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Interest-only loans are a type of
mortgage. |
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They
are not. Interest-only is an ‘option’ that can be attached
to any type of mortgage.
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For
example: a 30-year fixed rate mortgage of $100,000 at 6% has a
monthly payment of $599.56. This is the fully amortizing
payment -- the payment which, if maintained over the full term
of the loan, will just pay it off. |
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In
month 1, that payment divides into $500 of interest and $99.56 of
principal. In month 2, the payment remains at $599.56 but the
breakdown is $499.50 and $100.06. Each month, the interest portion
declines and the principal portion will rise. After 5 years the
balance is $93,054. That is how mortgages amortize.
By
attaching an interest-only option to this mortgage for the first 5
years, you will pay only $500 a month during the first 5 years.
There is no payment to principal.
If
you exercise the option, the balance after 5 years is $100,000;
there is no amortization. Beginning year 6, the borrower must begin
paying $644.31. That is the fully amortizing payment for a 6% loan
of $100,000 for 25 years.
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Pre
Qualify 10 Minutes
- Happy Families Since
1997
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Misperception
2
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It is less costly to amortize an interest-only loan.
Absolutely
not.
If
you take the mortgage as outlined above with the interest-only
option, but decide to pay $599.56. If you don’t exercise the
option but make the fully amortizing payment instead, the loan will
amortize just if the interest-only option had not been attached.
After 5 years, the balance will be $93,054. If you make the same
payment on the same mortgage, the results are the same.
If
you pay $700 a month instead of $599.56 on the same mortgage, the
balance after 5 years will be $86,046. Whether or not the mortgage
has an interest-only option it will not matter.
TOP
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Misperception
3.
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An
interest-only loan carries a lower interest rate.
Lenders
might charge a higher rate for a loan with an interest-only option,
because the risk of default is a little higher on loans that
amortize more slowly. But a lower rate would be irrational.
The
notion that interest-only loans have lower rates arises from
comparisons of apples versus oranges. Adjustable Rate Mortgage (ARMs)
with an interest-only option has lower rates than a Fixed-Rate
Mortgage (FRMs) without an option. But an Adjustable Rate Mortgage
with the option does not have a lower rate than the identical ARM
without it.
Since
the interest-only option is available on both Fixed-Rate Mortgage
and Adjustable Rate Mortgage, it is pointless to choose an ARM
because of that feature. First choose whether or not you want an ARM
or a Fixed-Rate Mortgage. Base this decision on how long you intend
to have the mortgage, and on your willingness to accept the risk of
a future increase in the interest rate in order to have a lower rate
in the short-term. If you opt for an Adjustable Rate Mortgage, then
select the other ARM features you want, including an interest-only
option. TOP
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Misperception
4.
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On an Adjustable Rate Mortgage with an interest-only option, the
quoted interest rate is fixed for the interest-only period.
This
may or may not be the case. Where it is not the case, may be the
most dangerous misperception of all, it can induce you to take an
Adjustable Rate Mortgage that don’t meet your needs.
The
interest-only period is the period during which you are allowed to
pay interest only. The period for which the initial rate holds is a
different matter altogether. On an Adjustable Rate Mortgage with a
very low rate, the interest-only period is always longer than the
initial rate period.
A
common Adjustable Rate Mortgage today has an interest-only option
for 10 years, but the initial rate holds only for 6 months. On a
$100,000 loan with an initial rate of 4%, the interest-only payment
is $333. If the rate after 6 months goes to 6%, the interest-only
payment would jump to $500. Borrowers who thought they were safe for
10 years would get a harsh awakening. TOP
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Misperception
5. |
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Interest-only loans are appropriate if you don't expect to be
in the house very long.
No.
If you don't expect to have the mortgage very long it makes sense to
select an Adjustable Rate Mortgage because the rate will be lower,
and it makes sense to avoid paying points because there won't be
much time to recover your investment through a lower rate. However,
the decision to take an interest-only should not be affected by your
time horizon.
TOP
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Misperception
6. |
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Interest-only loans don't require PMI.
Some loan officers
are shameless in the stories they tell borrowers. Of course, some
interest-only loans don't require PMI because the loan is too large
relative to the borrower's equity, or the deal is otherwise
sub-prime. In these cases, you are paying the insurance in the
interest rate.
If
there is a loan that requires PMI but does not require it if the
loan has an interest-only option attached, it is because the insurer
doesn't want the greater risk entailed by the PMI. In such case, the
implicit insurance premium in the rate is bound to be larger than
the PMI premium. TOP |
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727.388.3376
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e
"g" |
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Refinance Now! |
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