An interest-only loan is a fairly simple mortgage product. While calculating the financial differences between this option and other mortgage products can be complicated, the loan itself is fairly straightforward.
An interest-only loan is a mortgage product that has an introductory period when you only pay interest and do not make payments towards the principe. Usually lasting about 5 to 10 years (although it can be longer or shorter), the introductory period allows you to enjoy lower payments while the amount that you still owe does not go down.
Once the interest-only period is complete, the loan converts into a typical amortized loan, usually a fixed-rate loan. At this point, you pay both interest and principle and gradually reduce the amount you owe until the loan is paid off, just as you would with any other loan.
Converting to a more typical loan, however, is not the only option. You can also pay off the loan if you have the finances, or you can refinance. This last option, of course, assumes that refinancing is available and worthwhile, which is not always the case.
With so many variables, including interest rate, interest-only period, loan total, downpayment, and more, the details for this type of loan can get complicated. But in a nutshell, these are simply loans with a short period of low payments followed by a period of higher payments.
Comparing Fixed-Rate vs Interest-Only Payments
Interest-only loans are often compared to fixed-rate loans. This is where things get complicated, as there are just so many variables. You can adjust dozens of dials that change how these two loans differ, so we’ll try to simplify as much as possible to create a fair and honest comparison.
Generally, interest-only loans are used for larger purchases. While you can certainly use them for smaller amounts, many property buyers use interest-only jumbo loans, which can include millions of dollars in financing.
Therefore, we’ll compare interest-only vs fixed-rate loans with an amount of $1.5 million, which is not the largest loan possible, but it certainly would count as a jumbo loan for a single-family property.
Note: Numbers are for general information only and do not represent a perfect calculation on your loan. For accurate and specific calculations on your potential loans, contact our team.
If we assume a $1.5 million loan, eliminate all other variables (downpayment, discount points, etc), and use a 4% interest rate, we can get a fairly good idea for how these loans compare. For the interest-only loan, we will assume an interest-only period of 5 years.
With an interest-only loan, you would start with an introductory period that has a monthly payment of roughly $5,000. Throughout this period, the loan balance would remain $1.5 million. After making these payments for five years, you would then convert to a principle and interest payment of roughly $7,900, which would be your payment for 25 years, assuming you keep the home.
With a fixed-rate mortgage, you would start with a principle and interest payment of roughly $7,100, which would be your payment throughout the 30-year loan. (Again, assuming you keep the property.)
So in this scenario, using the interest-only loan would save you roughly $2,100 a month for the first five years. Over five years of payments (12 months a year would mean 60 payments), you’re looking at a savings of roughly $126,000!
When is an Interest-Only Loan a Good Idea?
While we can’t say that interest-only loans are perfect for everyone, there are a variety of situations when this type of mortgage would be ideal.
Usually they are best for someone who doesn’t plan to live in the home for a long time. If the property will be your home for life, the place where you start a family, raise your kids, and go through retirement, then it may not be the best option. However, if you expect to only live in the house for a short period, this program may be useful. If you will sell the house in a few years, or you expect to be moving in the near future, perhaps because of work or another issue, these loans could be beneficial.
If cash flow is a concern, you may want to consider an interest-only loan. These loans are perfect for investors who want to purchase income-generating properties while maintaining a large supply of liquid cash, then sell the property, or pay off the property, when the interest-only period is complete.
High net-worth buyers who don’t want to tie their capital into large investments will appreciate the benefits of these loans, especially if they plan to reinvest the difference that would be paid on a typical fixed-rate mortgage.
30-Year Fixed-Rate Interest-Only Loan Available Now
At San Diego Purchase Loans, we strive to provide mortgage products for any buyer in any situation. If you think an interest-only loan would be right for you, give us a call to learn more about our 30-year fixed-rate interest-only loan program.
Because of heightened financial risk, this program actually went away during the COVID-19 pandemic, but it’s now coming back. It is a 30-year loan that starts with an interest-only payment for the first ten years, then converts to a 20-year term that has the same interest rate.
During the ten years, you can make additional payments to reduce the balance in addition to the interest that is due. This is a popular feature, as it allows the loan balance to fall, which means a lower payment the next month. It’s a great way to maintain cash flow if you need it. With this loan, you can reduce the principle any time you want and get a low monthly payment.
If you want to learn more about this excellent financing option, contact our staff today. We’ll explain all the essential details so you can make the right choice for your next property purchase.