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Interest-Only Mortgages And Facts That You Need to Know


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NOTE: Do not let the ballyhoo over interest-only mortgages mislead or confuse you, as always, get the facts, due your research and educate yourself before signing. They may or may not be the solution to your mortgage needs.

Do not be mislead, there is no such thing as an interest-only mortgage because you will always have to pay the loan principal as well. What it is in actuality is an interest-only payment technique which when coupled with any kind of traditional mortgage can offer some benefit.

These benefits, however, are most often not as spectacular as the lender would want you to believe and carry some risk. When you take out a standard mortgage during the early years of repaying it the interest is equal to about ninety-five cents of every dollar you pay back. If the standard payment on a $100,000 loan is 6%, or $600, of that $500 is going towards the interest re-payment. Further, whenever your payments towards the principal get smaller you will be paying more interest in the long run.

History and Background on Interest-Only Mortgages

Interest-only Mortgages evolved out of what's known as the jumbo loan market, which is known to be less rigid and offer more maneuverability than the Freddie Mac and Fannie Mae programs with their loan amount ceilings. The target group for these mortgages was the more affluent and knowledgeable property investors. These high-end investors prefer to use their principal portion of the payments for other productive investments and not have it tied up otherwise.

Now, due to the fact that the loans were most often in the jumbo end of the loan spectrum the difference in monthly payments is substantial. If the loan is for $1,000,000 dollars what was cited as an example of a $100 difference before is now a striking $1,000 per month, a sum that can be used elsewhere for substantial gain within another investment. By choosing to put the $1,000 dollars to use in, let's say the stock market, the investor may realize much higher returns. This in turn helps the investor to leverage their income to build good asset strength.

Because this type of investing and juggling of assets is not to be undertaken by anyone who has little or no resources to back them up, should their stock investment turn out to be to volatile, anyone not affluent enough to play this strategy is advised to steer clear.

Interest-only mortgages are available to most anyone who qualifies for a loan, be it an ARM or a typical FRM.

The Fannie Mae program purchases from lenders a type of a FRM with interest-only payments, called "Interest First". Featuring back-to-back 15-year terms, with the first period comprised of interest-only payments and the second fully amortizing, a borrower can expect to pay a little extra for this product.

Not Forever

Interest-only and Interest First loans are only allowed during a portion of a loans term and will most often expire at the end of a very definitive time frame. They are well suited to being apart of any Hybrid ARM's structure though and once the interest-only portion is satisfied the payments will escalate to include both principal and interest.

Buyers Who Leverage Debt

A way to borrow more money and not increase your monthly payments is to "leverage your debt". As we pointed out in the example above, if you are making a $600 dollar per month contribution toward your debt service $500 of it is going towards interest and $100 towards the principal. So if you make an interest-only arrangement, all $600 of the payment will go towards the interest costs.

The extra $100 per month can provide you the leeway to borrow an additional $20,000. This can be an asset to you if you really want the home in question and there is a bidding process between yourself, other interested parties and the seller. It could make the difference between winning the bid and having to go look elsewhere for your dream house. These kinds of extra funds can also help you to purchase a larger house or one situated on a bigger plot.

Borrowers that chose to use this type of approach aren't "cash-flow" or "income-leveraging" borrowers. What they're actually doing is incurring or buying more debt, so you could say they are "debt leveragers".

What Is the Risk Associated With Leveraging?

It is important to keep in mind when leveraging debt that a lot depends on the very good expectation that your income will increase over time and that the property will increase or appreciate in value. By not reducing the principal's balance no equity is realized in the home and you must rely on the market to achieve that increase for you by going up.

All of this is a gamble, and if you are not confident that your income level is going to rise. you cold get stuck when the substantial increases in payments come due.

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