"Interest-Only Mortgage Payments are Much Lower." True or False?
Interest-only payments and 40-year mortgages have been a frequent topic of discussion lately, both in group meetings and in direct phone calls. To make the very best decisions for your business and your family, I want to be sure that you are fully informed.
The conversation usually begins something like,
“Someone told me that my mortgage payment will be much lower if I get an interest-only loan. That’s what I want.”
Like so much of investment real estate, we have to start with, “That depends.”
It’s not interest-only for 30 years. While the interest rate is fixed for the whole term, which may be 30 or even 40 years, the interest-only payments are just for the first 10 years. After that, the outstanding principal balance is amortized for the remaining term, which would be 20 or 30 more years, so that the loan is paid to $0 at maturity. At the end of the interest-only period, the payments become principal and interest, just like your standard homeowner mortgage.
The interest rate is higher. A 30-year amortization (the balance is $0 at the end of the term) is the industry standard at this time. Because an interest-only loan takes longer for the lender to receive their principal back, this repayment type represents higher risk for them. You, the borrower, pay for this additional risk in the form of a higher interest rate than what you would pay on a standard mortgage payment structure.
The payment often is only a little bit lower. I recently shared in a group that the particular loan under discussion would be a savings of, “tens of dollars per month.” Because the loan amount was relatively small, there aren’t enough dollars total in the transaction to move the needle very far. In the $140,000 example below, the 40-year mortgage payment is only $62 per month lower than the 30-year amortized payment.
The payment can be much higher after the interest-only period is over. Logically, if you pay off a principal balance in 20 years at a higher interest rate, those payments have to be greater than 30 years at a lower interest rate. In the chart for the $440,000 mortgage, the payment during the amortizing phase of the 30-year with interest-only period mortgage is $558 per month greater than the 30-year amortized payment.
The money borrowed is more expensive. Each dollar borrowed simply costs more, but you do get to keep it longer before you have to return it to the lender.
The following two charts provide examples you can evaluate side-by-side. The first is an example of a $140,000 30-year amortizing loan, with a 30-year with interest-only option, and with a 40-year with interest-only option. As you review it, consider the common misconception that the interest-only mortgage payment is “much lower.” The initial difference is as low as $62 per month less, and flips to as much as $177 per month more.
The second is an example of a $440,000 30-year amortizing loan, with a 30-year with interest-only option, and with a 40-year with interest-only option. In this example, you can see the impact that the same circumstances have on a substantially larger loan amount. The total interest paid is as low as $587,380 and as high as $959,563.
These charts will give you the basic knowledge to apply to your own circumstances. Keep in mind that, statistically, the average mortgage is only held about 7 years before it is refinanced or the property is sold. So you’re probably not going to pay for any of these example loans for their full term.
Sometimes there are good reasons for an interest-only payment. I have an interest-only loan on one of my own investment properties. Just be sure that you are considering all of the ramifications beyond someone telling you that it will cost less per month.
Take a look at the charts, and reach out to me with your questions and investment real estate financing needs. Email [email protected] or visit krisfleming.net/financing for more information.
This is not a commitment to lend. All applications are subject to credit and underwriting approval. Programs, rates, terms, and conditions are subject to change without notice.
Barrett Financial Group LLC, NMLS 181106
2701 East Insight Way, Suite 150
Chandler, AZ 85286
Kristin Fleming NMLS 804170
Licensing Information: https://www.barrettfinancial.com/licensingorhttp://nmlsconsumeraccess.org/
