In an interest-only loan, the mortgage does not reduce the principal loan amount but the monthly installments that cover the loan’s interest. This means that as the borrower, you will always owe the same amount because you will only be paying the interest. One of the reasons you’ve probably not heard of these loans is because they are not for everyone. It is the property that is bought which secures these loans. There is another option of paying more than the interest, but most people do not take it. The loan lowers the installments that are made each month on the mortgage. However, the loan has high risk, but when used under the right conditions and planning, an Arizona interest-only mortgage loan can be beneficial.
How the loan works
Just as the name suggests, with interest-only loans, when calculating the monthly installments, only the loan’s interest is required to be repaid every month. The primary loan is customarily left out in these calculations. To make this statement more clear, let’s say a borrower will take an initial loan of $100,000 that has a 6.5% interest that is repaid over 30 years. This will give a monthly repayment of $627, and this includes both the principal and the interest. The interest part of the loan amount is typically $514.50. This implies that you will save $85 every month when you take the interest-only loan.
Different types of interest-only mortgages
There is the lack of an unlimited term in most mortgage types offering the interest-only option. This means that you will not continue paying for the interest for eternity. There will be a particular time when the principal loan will be fully reimbursed over the remaining term of the loan. For example, with a 5/20 mortgage, it will allow interest-only payments for the first five years of the 25-years term. After the five years, the initial amount of the loan will be reimbursed over the remaining 20 years of the original term when both interest and principal amount will form a part of the monthly reimbursement. For instance, let’s you’re with a 30-year mortgage which has an option of paying only 6.5% interest for the initial five years on the principal loan of 20,000. This will give a monthly reimbursement of $1083 for the initial five years and $1264 for the remaining 25 years of the term.
Calculating interest-only payment
There is a simple formula for calculating the interest-only payment. The first step is to multiply the rate of interest by the amount of the loan. For instance, in the example given above, this would be $200,000 multiply by the 6.5% providing a yearly interest of $13,000. The next step is to divide the result by 12 months to get the monthly rate, which is $1083.
Benefits of interest-only mortgage
This loan is necessary to first-time homebuyers who do not have enough income to afford to reimburse a traditional mortgage. These, therefore, prefer to rent than to buy.
The reimbursement associated with the interest-only mortgage provides homeowners financial flexibility to the unprecedented circumstances. This implies that people can pay their monthly interest rates when the financial times are okay and pass them when they are bad or during emergencies.
The loan is also beneficial to the self-employed people, those earning commissions, and those who do not have a stable monthly income. During the good financial times, borrowers can pay more towards the principal amount and pay for the mortgage interest during the low economic times.
One downside of this loan is that it is a bit more expensive compared to other conventional mortgages. This can be attributed to the high risk faced by lenders. However, the difference is not very huge and is mostly as low as 0.5% charged interest on the initial amount. There can be extra charges depending on certain circumstances.
Misconceptions and associated risks
The main misconception on the Arizona interest-only mortgage loan is that the balanced owed does not increase as in the ARM loans. Increasing the balance does not apply to the interest-only mortgages and is referred to as negative repayment. The main risk comes in when the property being sold has not increased in value. Since you will be paying on the interest-only, the principal amount will not reduce, and hence the loan amount will not change. This means that when the whole amount becomes due, the homeowners will run a loss.
This risk is also run when using other conventional mortgages. You will hardly find loans that will cover the property’s selling costs, especially when they have not increased in value. There will be a significant down payment to reduce the risk factor associated with the loan.
A dip in the property market can also lead to equity loss on the property. However, this risk is faced by all homeowners regardless of the loan types they are using. Therefore, before making any mortgage decision, consult our Arizona interest-only mortgage experts to get the best option. Contact us today.