Interest only loans* have a negative connotation for a lot of people. When most people think of "interest only" loans they think of an adjustable rate loan that adjusts once a month and their perception is that it is too risky, but an adjustable rate interest only loan can actually be an excellent loan to have as long as you know what you are getting into.
We offer mortgage loans with an interest only option, but we do not offer "payment option" arms or any loan with negative amortization.
Many adjustable rate programs are LIBOR (London InterBank Offer Rate) indexed arms, but we also offer an interest only option with our 30 year fixed rate loans. This has been our most popular loan program for people that want the stability of a fixed rate, but the option to pay principal with no prepayment penalty. The 30 year fixed rate interest only loan is an often overlooked option as it gives you the security of a 30 year loan, but a 10 year interest only period on the front end to allow you to make the lower payments when you may need or want to do so
The rates for all adjustable rate programs are calculated by adding the margin (usually between 1.25 to 2.75% depending on the program and whether you pay points or not) to the index. This figure is subject to what is called a "cap." Most interest only LIBOR loans have both a low "margin" and low "caps," and while this is a very simplified explanation of these loan products you can see where even at a more typical average for the index of approx. 4.75%, that these rates can be a decent deal. In other words, if the 6 month Libor Index is at 4.75% and your margin is 2.0% then your interest rate would be 6.75% - not a bad rate by historical standards.
Many in need of a jumbo interest only loan prefer a "hybrid arm" that is fixed for 3, 5, 7 or 10 years before it adjusts since a lot of people only stay in a house for 5 to 7 years. Hybrid arms give you a lot of security (and savings) and the loan might still have an attractive rate at the end of the fixed period.
Many of our clients with jumbo and super jumbo loans prefer interest only loans because with larger loans the interest only option has a greater the impact on the monthly payment and one nice feature of most interest only loans is that if you make extra principal payments in any given month your next month’s payment will be calculated based on the new loan balance. This is especially helpful if you are making scheduled prepayments of principal or a lump-sum prepayment, because the additional principal will immediately reduce the balance owed and your next months payment.
Interest only adjustable rate loans that adjust more frequently may not the best option for someone planning on being in their house for a very long time given the current low interest rate environment, but they are still worth considering if your time horizon is shorter or if you have other plans for your money.
What you need to consider regarding interest only mortgage loans:
- how long will you be in the house
- how likely you are to handle the potential volatility of the payments once the loan starts adjusting and as the index rises and falls
- if the value of the home is likely to rise so that you are gaining equity whether you are paying principal or not
- if you are likely to do something better with the "savings" from the lower payments (invest, save for college or retirement, improve the property, pay down other higher interest debt, etc.)
*Interest Only Loans allow you to make payments that are less than a principal and interest payment for a fully amortized loan of the same amount. You may pay just the accrued interest during the interest only period, then full principal-and-interest payments for the rest of the term of your loan which will increase the monthly payment due. This is the case with a fixed rate or an adjustable rate. Some interest only loans have higher rates than principal and interest loans and could result in a higher APR.
