Non-QM loans, on the other hand, don’t rely on traditional income verification methods. This can make interest-only loans attractive prospects for real estate investors and other individuals whose income isn’t accurately reflected on tax returns, W-2s, and other income documents. Interest-only loans and traditional loans serve different purposes and work in different ways. With a traditional loan, each monthly payment includes both interest and a portion of the principal. Over time, this reduces the amount owed, making it easier to build equity in a home or pay off a debt.
As an example, let’s say you’ve borrowed $250,000 at an interest rate of 3.75%. On a 30-year, fixed-rate loan with an interest-only period of five years, your payment would be $781.25 per month for those first five years. Once the principal payment kicks in, your payment would then go up to $1,285.33 each month for the remaining 25 years of the loan. The biggest draw of an interest-only mortgage is that you’ll pay less each month than if you were putting money toward the principal. Chase online lets you manage your Chase accounts, view statements, monitor activity, pay bills or transfer funds securely from one central place. For questions or concerns, please contact Chase customer service or let us know about Chase complaints and feedback.
Alternatives To An Interest-Only Mortgage
However, due to the increased risk involved with the interest-only period, they might have stricter credit requirements than their principal-and-interest home loan offerings. It will also depend on each individual borrower’s personal and financial circumstances. If the value of your home doesn’t increase during the interest-only period, you aren’t increasing your home equity. This is because the repayments you’re making aren’t going towards the loan’s principal, so the equity in the property remains the same.
However, you have the option to put down only 3.5%, though you’ll only qualify if you have a minimum 580 credit score. When the initial period ends, the loan will convert to an amortization schedule. You’ll make larger payments that go toward both the principal and interest for the remainder of the loan term. Having low monthly payments for the first several years you own your home can be a big relief, but there are also many drawbacks and risks that come along with interest-only mortgages.
They can help you assess your eligibility, understand the risks and benefits, and choose the best loan option for your needs. You can also utilize online mortgage calculators to estimate your potential monthly payments and compare different loan scenarios. Investors may opt for these loans to minimize initial expenses, aiming to sell the property at a profit before the higher payments commence. This strategy relies on property appreciation and can be risky if the market doesn’t perform as expected.
Don’t Sleep on the Fine Print
- Extensions aren’t guaranteed, you’ll need to negotiate with your lender, and it often depends on your credit and financial situation.
- If you have earnings that fluctuate or are unpredictable, it might not be smart to get a loan that’s also hard to predict.
- Businesses sometimes use interest-only loans to keep cash flow available while they invest in growth.
- After the introductory period ends, the borrower starts repaying both principal and interest, and the interest rate will start to vary.
- Your monthly payments increase to include both principal and interest, often calculated over the remaining loan term.
That means you’ll pay $43,054 more for the interest-only loan, with the trade-off being the lower payment for the first seven years. Your income is the biggest consideration with an interest-only mortgage. For instance, this type of mortgage could be useful if you’re confident you’ll earn more money down the road. If you know you’re going to get your annual bonus at the end of the year or you’re due for a raise soon, it could be the right fit. Like any financial product, these loans come with upsides and serious trade-offs.
This method isn’t as common as switching to interest-and-principal payments, though. The interest-only period comes with a short term, usually 10 years or less. After that, you’ll start making full interest-and-principal payments or will owe the remaining balance all at once.
Many borrowers also plan to sell or refinance after a short period of time, which allows them to get out of the mortgage before it ever requires them to make those larger principal-and-interest payments. Most interest-only loans are structured as an adjustable-rate mortgage (ARM) and the ability to make interest-only payments can last up to 10 years. After this introductory period, you’ll start to repay both principal and interest.
If you plan to own the home longer than the interest-only period, you will need to afford the monthly payment when it increases. You’ll also need to understand that not paying down the principal means the only way you can build what is an interest only loan equity is if your home increases in value. If your home doesn’t increase in value, you’ll have no equity, which may make it difficult to sell or refinance your home. Since monthly payments are much smaller on an interest-only loan than they would be on a traditional one, it can free up a lot of household cash flow — at least for the initial few years of the loan.
An interest-only mortgage is a home loan that has very low payments for the first several years that only cover the interest owed — not the principal. These lower initial payments may last for as long as 10 years, but after that you’re required to start making payments toward the principal balance. While your payments may change once you start paying toward your principal balance, the rate of interest you’re paying will never fluctuate for as long as you have the loan. The good news is that adjustable rates are starting lower than fixed rates right now. But if rates rise in the future, your adjustable rate could increase, too.
- During this phase, monthly payments are lower because no principal is being repaid.
- OneMoneyWay is your passport to seamless global payments, secure transfers, and limitless opportunities for your businesses success.
- However, if business growth doesn’t happen as planned, repaying the loan later can become a major challenge.
- Invest on your own or work with an advisor — we have the products, technology and investment education, to help you grow your wealth.
Important Factors to Consider with Interest-Only Mortgages
Ultimately, you’ll pay a premium for the privilege of making low, interest-only payments for a period of time. The appeal of an interest-only mortgage is the lower initial payments, but you’ll need to balance those upfront savings with higher overall costs. That freed-up cash flow could make for other investment opportunities, too. You may be able to invest more money in the stock market, your 401(k), or even other real estate purchases that can help you build your wealth.
Interest-only mortgages are nonqualified mortgage (non-QM) loans, which means they come with features that the Consumer Financial Protection Bureau (CFPB) considers potentially risky. These include the interest-only period itself as well as, in some cases, a balloon payment. For this reason, interest-only loans don’t qualify for government-backed programs, like FHA, VA or USDA loans.
