If you are looking for a less expensive mortgage payment, one way is to strip it all the way down to just interest. That is what the interest only mortgage is. This type of mortgage requires you to only pay on the interest on the loan, which is simply the cost of the money you borrowed. You are not paying back the principal. These types of loans are harder to get and not as common as before the housing crash of a decade ago. Below is more information about no interest loans and how to get one.
Find Out Why So Many Borrowers Are Choosing the Interest Only Mortgage Option in 2018
Interest only home loans are usually set up as an adjustable rate mortgage and usually has a term up to 10 years. After this point, you are required to make amortized payments that include interest rate charges and principal. The other options are to pay off the loan in full or to refinance.
For instance, say you get an interest only mortgage for $500,000 with a 5% rate for five years. The interest only payment is $2083. After five years, the rate is adjustable on an annual basis, but it is still an interest only loan. Now let’s say the rate goes up to 6%. The interest only payment will be $2500.
If the rate continues to rise, and by the end of year 10 you must make interest and principal payments, you could eventually be paying 7% interest and have a payment of $3,876.
At the conclusion of the interest only term, the above example is 10 years, you may be able to refinance your loan balance into a new loan if a better interest rate is out there. But the problem with this is it is impossible to predict what rates will be with any certainty in several years. Even trying to guess what they will be in several months is difficult.
Qualifying for an Interest Only Mortgage
The reason that interest only loans are more unusual today is they are more difficult to qualify for. You typically need a higher down payment, a lower debt to income ratio and a good credit score. It would be rare that you could get an interest only loan with a FICO score under 700. You will certainly have to show the lender that you have solid financial assets and the ability to pay the loan.
Who Gets Interest Only Mortgages?
It depends, but many Interest Only Loans are for people who will probably not stay in the home for a long time. Most of these home owners are thinking of staying in the home for five or 10 years. The best borrowers for interest only loans have a lot of cash in the bank and a strong financial position. The fact that their loan is not reducing the principal is not a risk for them.
Some of the common types of interest only mortgage borrowers are those with:
- A lot of monthly cash flow
- A rising income
- A lot of cash in the bank
- Income that varies each month
Interest only mortgages can be a good choice for people who have the financial discipline to make a principal payment periodically. This can also work for the worker who is in a job that pays annual bonuses each year that can be used to pay down the loan principal every year.
Another type of person who might use an interest only loan is a couple getting close to retirement who could use an interest only loan to purchase a second home. They might sell their first home when they retire, move to their second home and then pay off the loan in full.
But keep in mind that interest only mortgages are not usually a good choice for the first time or conventional long-term buyer. Getting these loans is harder than it used to be because the loans are not purchased by Fannie and Freddie, so they are much harder to qualify for. Lenders must hold them on their own books or sell them to private investors.
An interest only loan can be a good fit for a higher income borrower with assets, but it is probably not appropriate for the first-time home buyer and is quite difficult to qualify for anyway.