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You are here: Home / Boulder Real Estate Blog / What is an Interest-Only Mortgage?

What is an Interest-Only Mortgage?

June 19, 2017 by The Boulder Property Network

The following article is a summary of content from the book, “Realtor for Life,” written by Duane Duggan, REALTOR & Author with RE/MAX of Boulder

The 30-year fully amortized loan has been the mainstay of real estate financing in the U.S. for decades, yet market conditions often bring about different types of mortgages to help buyers get into a home. At one time, there was a loan called FHA 245, which was a graduated payment, negative amortizing loan. The payments were kept low because the shortage of what the payment should have been was added to the loan balance each month. This worked decently in an accelerating market, but not so well in a declining market.
Another tool to help buyers in an accelerating market is the interest-only mortgage. During the pre-2007 real estate market, home prices were rising rapidly, and this was a tool to help keep payments lower. Interest-only mortgages got a bit of a bad rap because consumers were missing out on getting the loan paid down when home values began to decline. Since the loans weren’t being paid down, the homeowner became more likely to be foreclosed upon.
When a market accelerates, interest-only mortgages become more commonplace. This is because home prices are accelerating faster than salaries, and the consumer looks for ways to afford a home.
There is definitely a time and place to use the interest-only loan as a tool.
One example I have is when I had a client who had been laid off from his job. This client had other income but the fully amortized payment was making things pretty tight. By using an interest-only mortgage he was able to reduce his payment and stay in his home.
A feature that interest-only loans have is that if you pre-pay any principal, the next month, the interest-only payment is based on the remaining principal balance. That means the payment goes down immediately. That is a big difference from a 30-year amortized loan. On a 30-year amortized loan, if you pre-pay principal, it reduces the term of the loan, but the payment remains the same.
With the interest-only loan, if you are disciplined enough in making extra principal payments, the monthly loan payment will go down each time you do.
Just this month, interest-only loans have returned to the marketplace for primary residences and second homes. The typical product structure is 3,5,7,or 10 year fixed, then becomes an ARM (Adjustable Rate Mortgage). In general, qualifying is more stringent than for a typical mortgage and down payments are larger.
Doing a quick check with lenders today, I found that interest-only loans on investment properties aren’t available. When they do become available, they are a wonderful tool. Each time you make an extra principal payment, next month’s payment is lower, and the cash flow gets better. As the cash flow improves, you can keep applying the increased cash flow to principal and before you know it, the loan is paid off!
Contact a mortgage loan professional to see if an interest-only loan is something that would work for you if you qualify.

Duane Duggan has been a Realtor for RE/MAX of Boulder in Colorado since 1982 and has facilitated over 2,500 transactions over his career, the vast majority from repeat and referred clients. He has been awarded two of the highest honors bestowed by RE/MAX International: the Lifetime Achievement Award and the Circle of Legends Award. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life.
For questions, email Duane at DuaneDuggan@BoulderCo.com

 

Filed Under: Boulder Real Estate Blog, Duane's Timely Topics, Real Estate Investment Information

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