Any Interest in Interest Only?

by Michael Eastham, CPA CRMS

Today in the mortgage industry there are so many loan programs available that it can make your head spin. Each one was developed as a solution to a certain problem. So it is with the interest only mortgage. Although this program has been around for years, in days gone by it was typically reserved for those higher net worth borrowers that had a short term need for money or who had a better use for their money that to use it to pay back the principal on a loan. It was offered by very few lenders and those that did were typically large securities firms that offered this solution to its clients with substantial assets under management. In many ways these providers had it right. What I mean is these companies viewed their clients very much as they would a corporate borrower that sold a corporate bond issue. Companies issuing these types of investments make interest only payments, typically quarterly, so that they are able to manage their cash flow better and put there working capital to use in ways that will enhance their businesses. Utilized in the proper way, that is precisely what an Interest Only mortgage provides.

Many people today may frown on this loan program because it is not in the mainstream of what previous generations have grown accustom to. That is, paying a fixed principal and interest amount each month for 30 years. Well, many things have changed and in today’s investment environment we view the interest only mortgage as a viable option for some investing in real estate, whether it is for your own home or investment property. Now, before I get my head chewed off by fiscal conservatives, let me say this: An interest only loan is NOT for everyone.

There, is that better? Now that I got that off my chest, there are several compelling reasons to consider this loan product as a viable financial tool in your personal financial toolbox. I will only address a few of them here. First, with interest rates so low, it is not that difficult to find better places to invest the money that you would otherwise be using to pay down principal on your mortgage loan. Utilizing the skills of your financial planner, you may receive a much better return on your investment. Another scenario where the Interest Only loan may be an excellent choice is if you do not plan to live in a home for a significant period of time, but want to receive the maximum tax benefit. Further, if you are planning a purchase in a location where real estate appreciation is rapid, it is likely that the equity in your home will increase much quicker through appreciation than through paying down principal. An interest only loan can also allow a buyer to purchase a home that he or she would not otherwise qualify for using a traditional 30yr fixed rate loan.

There are several “flavors” of this loan as well. Each one caters to a specific borrower profile. Most are interest only for a fixed number of years and then they are amortized out over the remaining life of the loan. For example a 3/27 Interest Only might be interest only for 3 years after which the balance is amortized over 27 years. Many lenders are now selling a Home Equity Line Of Credit, which is usually interest only, in a first lien position for both purchase and refinance. This option gives the borrower the ability to access equity via checks, wire transfers or even a debit card.

There can be a prepayment penalty attached to these loans if you prepay in excess of a certain percentage of the principal balance within a twelve-month period. So make sure that you talk to your mortgage professional about this issue before you are sitting at the closing table.

As you can see, there are many options to choose from when making a mortgage decision. Make sure that you at least consider the merits of the ones that can add value to your personal investment profile and can help you accomplish your objectives.