Interest Only Mortgage?

10/1 arm?

My wife and I are looking at the same option. Would you mind if I ask you 1.) Are you buying in Manhattan? 2.) If so, condo or coop? 3.) Approximately how expensive is the place you're buying and how much of a mortgage do you plan to take out? The reason I'm asking is because we were quoted a best rate of 0 points, but 6.375% for this kind of mortgage. I would love to know who's quoting you a 6% rate, if you would share that information....

#2 - 10/1 ARM is only slightly better rate than 30 year interest only (for first 10 years). so it was recommended that we go with the interest only. plus over the first 10 years, your equity contribution is very little. at least, that's the idea...

to reiterate, as I understand it, this Interest Only option means you get a fixed rate throughout the life of the loan. for the first 10 years, you pay only interest, no principal. the last 20 years, you pay principal plus interest. if i have this wrong, someone please correct me!

#3 - please note I said it was 6% with ONE POINT. it was 6.25% with no points, I think. still a little better than what you were quoted. the quote was for a coop in queens, and i would need a mortgage for a little over 300k. if you are willing to post your email, i'll send you the broker's name and contact info. i'm sure he'd appreciate the referral. he seems like a nice, open guy (at least compared to my previous mortgage brokers, tho I have only worked with 2 others). he broke down what his cost was, what his take would be, etc as well as my stats.

"I wish I had done this with my current apt (considering selling now, 4.5 years after purchase). My 30 year fixed regular mortgage has reduced my principal owed by a whopping 4k in all that time."

roykirk1, can you explain why an IO mortgage would have been better if you haven't paid off much principal anyway? Is it because of the lower interest rate?

Also, is your current place a coop or a condo? I ask because many coops strongly frown on IO or ARM loans...thx

I'm fascinated to see this discussion because I thought that these new creative mortgages were the very things that everyone is screaming about with the foreclosures & the lowering RE market. Keep talking!

do you know the bank that is offering the fixed rate after the 10 years at I/O? Most of the I/O loans that I have seen are ARMs after the first x years.

I had a 7/1 arm which is great if you are 100% sure that you are going to sell in the protected period and that the market will continue to go up. Otherwise very risky. I am buying a new place, and didnt really consider due to the ARM risk after the initial period, but this is very interesting . . .

#6 please elaborate. I dont see how Interest Only would lead to foreclosure. At least not for another 10 years. lol.

This seemed appealing to me because:

a) rate is still fixed, so if in 10 years rates are a lot higher, I'm still locked in at 6% (though that point I will have a 6% 20 year mortgage)
b) based on my experience, in 4.5 years of ownership, my mortgage payments have paid down the principal by 4k. 4k!! meanwhile, appreciation is in six figures.
c) if i had taken 7/1 back then, I would have had a much lower rate, and silly me, I knew I wasnt gonna live here for more than 7 years... and i'm probably not gonna live in the new place for more than 10 years...

if u want creative, i hear in japan they have 100 year mortgages. hehe... how's that for an inheritance... though i think over their the culture would probably be different. to protect the "family name/honor" the kids would take over the mortgage rather than foreclose. wouldnt fly here in the US, I dont think.

i keep hearing about subprime lenders having problems. but i think that is a case of lending to unqualified borrowers.

can someone list out the risks of an Interest Only mortgage?

Make sure your rate is fixed after the 10 years. Make sure there are no fees for prepaying. I think the reason subprime IO's are causing headaches are they are ARM IO's with prepayment penalties... basically you're hit if you do nothing and you're hit if you prepay.

I don't have one, but I heard these are good for ppl with big bonus incomes since you have lower cash flow during the year and then can decide how much principal you want to pay every year.

I can try first, I guess:

1) If rates go up at the end of the 10 years, you are faced with significantly higher payments and no chance to refinance to a lower monthly payment.
2) If the RE market tanks, you could end up having less than 20% equity, which could trigger PMI, maybe other things). Though that is only slightly more risky than a standard mortgage.

What else?

...also with 30 yr fixed (or ARM fixed), prepayments don't seem to have that great an effect on your monthly payments because its mostly interest in the beginning. It really only shortens the duration of the mortgage, which doesn't help cash flow.

I am buying a Condo. I am taking a 5/1 Arm INTEREST ONLY at 5.5 or 5.625 percent. I am going to pay an EXTRA $1000 each month.

WHY?

I like that in case of loss of income I can pay IO, should I want to. I like that if I overpay every month, the actual payment will DECREASE every month. I like that there is no prepayment penalty.

I my scenario, this solution is the best of both worlds.

#8, are you the OP?

You state -"..based on my experience, in 4.5 years of ownership, my mortgage payments have paid down the principal by 4k. 4k!! meanwhile, appreciation is in six figures."

So why is this a bad thing? Am I missing something here? Your mortgage is based on the original price of your home, right? So you've only paid in $4k yet you can sell it for tons more. Isn't that what we call leveraged finance?

If you can get a 30-yr fixed with no prepayment penalties you can pay down more principal at anytime, so you can pay off in < 30 years. Reducing your overall interest payments.

Another worst case scenario & possibly why co-ops wouldn't accept them is that if you get into difficulties and/or the RE market tanks you have no equity so just walking away looks like a viable alternative. It's been known to happen.

13, with 30 yr fixed (or ARM fixed), prepayments don’t seem to have that great an effect on your monthly payments because its mostly interest in the beginning. It really only shortens the duration of the mortgage, which doesn’t help cash flow.

... thus IO's *might* be good for people with get large portions of their income infrequently.

don't pay down the I-O that is 1,000,000 or under. take the difference and invest it in a muni fun on a monthly basis. gives you much more flexibility when if you lose your job and net interest rate should be about the same. You home grows in value thae same no matter how much debt you have.

Interesting and not a bad thought... muni funds have rates that are comparable to mortgages is that why u specifically said muni?

... and why < 1M? Finally some intelligent conversation

I'm not #17, but under 1 Mil because mortgage interest deduction only applies to indebtedness up to $1 mil on a first or second home.

wow. lots of good discussion.

I am considering the IO because

(a) the mortgage broker brought it up as the most popular product right now. If everybody is getting it, there must be a reason?
(b) I like the idea of increased cash flow each month. Yes, its just a couple of hundred bucks, but thats my cable bill, dsl, electric, etc. Yes, at the end of 10 years, I will have less equity than I would have.. but frankly, not by much.

I will ask for details about prepayment and I will also double confirm that the rate remains fixed after the 10 years (in case the rates go up a lot). You never know, but as of now, I do not see us living in this (hopefully) new apt for more than 10 years.

Please, what other risks should I consider before pursuing this type of mortgage? I will also check to see if the coop board will have a problem with this type of financing.

I would look into one more issue -- what if you stay longer than 10 years, what does your new payment become? Remember the principal payments will then be only distributed over 20years vs. 30 years and your overall payment can get extremely high. There is a great calculator to see your exact monthly payments over the life of an I/O loan at:http://mortgages.interest.com/content/calculators/InterestOnly.asp

18 here, thank you 17 for the very nice tip.

The main issue is the whopping payment after the ten year period. . .could be ugly if you can't afford it.

op, you may not see yourself selling in 10 yrs, but if there is a housing slowdown, you may want to hold on longer... and a fixed rate helps you with that. I'm in the same situation so that's the big question I have.

#15, it's #13 here. Good point. I understand that with the IO it's spread over 20 yrs instead of 30, but with a 30-yr fixed, if you prepay a lot of principal would the bank re-calculate your total interest of the loan thus reducing the total amount of interest you pay?

Just don't understand the advantage of an IO unless you get a better rate or have cash flow issues earlier on during the term of your loan.

We were just in the same position. We were deciding between 30yr fixed or yr IO with fixed rate after 7 years. We chose the IO for cash flow purposes, put 25% down on our coop, and the coop was fine with it, after we also showed them that we qualified for the 30 year to reinforce that we were not doing this because of poor finances. You really do need to fgure out your exit options first though, per #14, and manage your downside risks. Start socking away some money to cover your higher payemnts after the 10 years, just in case. Also, keep your eye out for refinancing opportunities on a quarterly basis. I'm not too convinced though that rates will go much lower, so please don't use this as your only strategy. This is a great dicussion!

26, they both recalculate, but the 30 yr fixed is heavy interest at the beginning, so if you prepay the same amount for a fixed vs IO, u will see a much greater impact on your month to month cash flow with an IO. Try plugging into some calculators.

I was under the impression that actually in some cases the interest does not recalculate if you pay down the principal on some fixed loans; that is how they make money. The prepaymenst just reduce the principal you owe but not the overall interest calc which is fixed when you sig the mtg. Not 100% sure but I would double check that fact . . .

#2* & 29, thanks for the explanation. So it sounds like it's more of a cash flow issue - assuming the bank recalculates.

I'm also under the impression that many IO loans have prepayment penalties, which you must factor in when comparing - is this true? That it's more common for IO's to have prepayment penalties?

re: #21 "If everyone is getting it there must be a reason." Most of the US is in debt up to their eyeballs so I would say that 'everybody is doing it' is not a good argument. Caveat emptor = Buyer beware.

New Poster here:

#29 is correct - with a (standard) 30 year fixed, your monthly payment will never change if you prepay a portion of the mortgage at some point. You are simply prepaying some of the principal, and shortening the loan duration on the back end.

In the case of a 30 year fixed with the first ten years IO, every time in the first ten years that you throw money at your principal, the monthly amount you are paying will drop because you're paying interest on the principal (only). At the ten year point, your mortage will then, in essence, turn in to a 20 year fixed rate loan on whatever principal is still outstanding, at whatever interest rate you initially fixed at. At that point, if you pay down some principal, your monthly payments will stay the same but you'll be paying off the loan faster, just like the (standard) 30 year year fixed.

My wife and I are about to lock into one of these ourselves, and all we're doing is setting up what we call an 'mortgage account'. The money every year that we would use to pay down the mortgage during the first 10 years of our thirty year fixed/first ten IO is being invested at a better rate of return (after taxes and deductions) than the mortgage interest rate - so in a sense, we're just arbitraging. At the end of ten years, we'll take that money, pay off the entire loan or most of it, and be left with no mortgage or a very snall residual mortgage.

Poster #30 again:

Oh, and I forgot, buying doing this we're also keeping our hands on our own cash for the first ten years and not putting ourselves in aposition where we feel that too much of our net worth is tied to our home. I don't like to cosider my condo as an 'asset' per se, and this allows me to have the freedom of choice.

I don't know, but I think that IO terms have changed over the years... i think they had a negative connotation in the past, but are becoming more popular with no penalties? Also, IO's are commonly associated with 0% down which flippers used which I think is different then the products we are talking about.

#29, it is ture that when you prepay a portion of a fixed rate loan the extra you pay is used to reduce the principal. However, once your principa is reduced your monthly $ interest payment will also decrease because interest amount is a fixed % of remaining principal. What remains unchanged is your total monthly payment, but with your interest amount reduced more of your monthly goes to principal. Therefore you pay off the loan faster instead of reduce your monthly payment when you prepay.

Poster #32/#33 here:

In our case we're putting down 65% - 70%, and we're not flipping. I don't know about the connotation.

regarding negative connotation, i'm an owner and when i bought my first property, I scoffed the thought of an IO, but that was before I really did the calculations and research on its benefits vs an IO.

#32 and #33. Great post! I'm not the original poster but this has really helped me too!

I agree, this is one of the better discussions on this site. I'm concluding that with each loan - IO or fixed - you have to evaluate your own circumstances and read the fine print (prepayment penalty? points?) in order to figure out the total cost of your mortgage.

U.S. bank regulators were advocates of exotic mortgages, senator Dodd says

http://www.theglobeandmail.com/servlet/story/LAC.20070323.IBSUBPRIME23/TPStory/Business

If you didn't care to take care of your credit rating, you probably didn't consider prepayment and interest rates scenarios nor your worst case payments. S*%! happens but u can try to plan for it.

I am very interested in the 30 year I/O spoket to my morgage broker about this and he gave me a rate of 6 3/8%
This would be for a second home. Is this rate competitive? Any help or advice would be appreciative.

spunky:

Poster #32/#33 here. We are about to close in the next 30-60 days on our place, and my mortgage broker (whom I have worked with before and think is just terrific) has gotten us the EXACT same rate. So I guess that's what the best is, for now. Please, if you find something significantly better come back and post who and where!

I been doing the math and I still can't come up with the benefit of an interest only mortgage.
If you taked out a 500,000 30 year fix conventional mortgage after five years the net principle owed appears to be the same if you pay the extra 500 per month that you would apply to the principle on an I/O.
The only benefit of an I/O is for cash flow reasons. I'd rather pay extra principle (if i had extra laying around that month) on an 30 year fix and cut my principle even more.

44, the 30 yr is certainly "safer" so go with that if you're comfortable. Some people have a high percentage of their income come in a bonus so the lower cash flow is more convenient. Plus if you don't intend to be there for more then 10 years, why pump the extra 500 per month in every month? IO is not ideal for undisciplined ppl who cannot save and budget.

i make 60k a year, just an IO for a condo for 1.6M

Interest-only mortgages
As the name implies, these loans, usually an ARM or a hybrid, allow a borrower to make interest-only payments during the first five years or so. After that, borrowers are expected to repay principal and interest in order to pay off the loan within the remaining 25 years of its term.

Borrowers can be in for a big payment shock once the interest-only period ends because they have to pay off the entire amount borrowed in only 25 years, compared to the typical 30. Rising interest rates will exaggerate that shock. Typically this type of loan works best for a borrower who is certain he or she will be selling the home or refinancing within the interest-only period and is simply seeking to keep his or her house payment temporarily at its rock-bottom low. If combined with a low down payment, these can be very risky loans for borrowers because they may not find it as easy to refinance out of this loan as they had anticipated, especially if the value of their home has not grown enough to give them a good equity stake.

if you're making 60000 and taking out an interest only 1.6M mortgage... you're crazy! I honestly don't know how ridiculous that sounds as your mortgage broker must be an idiot! After your "interest only" is over is 5 years, you're still responsible to pay interest + principle in 25 years! That's a whopping $10,679 per month at 6.375% APR. If you're paying interest only for 10 yrs then back to principle + interest, that's $11,812 per month at 6.375% for the next 20 years thereafter.

If you're AGI is 60,000, you're practically only making $5,000 before taxes!

48, he was poking fun but hasn't actually tried to get a mortgage before so doesn't understand the thread. 60k can't qualify for crap here in nyc and everyone knows it

i got the loan, no doc, stated income lol:)

To poster #47:

We're not talking about an interest only ARM. We're talking about a 30 year FIXED rate mortgage, where the first ten years are interest only, and then the final twenty years are fixed at the original rate you signed at ten years previously. NOT an ARM.

Thought experiment:

You have $2 million in assets, which happens to be 100 percent liquid at the moment. You want to buy a new home in NYC, costs $1 million. You expect to live in this new home for 8-10 years.

Do you pay for it outright, or do you take out a mortgage?

I think most people would opt for the mortgage, yes? Put down 200,000 (only 10% of your total assets), get a tax deduction from your mortgage payments, and be invested in the RE market at $1million (so if market goes up 10%, you make 100k, not 20k). Basically, you are "highly" leveraged, but pretty safely so. Meanwhile, you can earn a return in a different investment on the 800k that would have gone into the apt if you purchase outright. (Course, no mortgage payments to make if you buy with no mortgage).

So, if you had the choice, why would you NOT opt for the IO option? What is the point of paying down the principal?

OK... given the above, why would you then choose to

sure, ok.
but what would Robert Kiyosaki do? or Casey Serin?

i can't see any reason to paydown principal unless market goes down, then you are paying interest on a overpriced property. If market keeps going up, you own the place and living more or less rent-free assuming you get all your taxes back based upon the mtg interest deduction

Paying IO is a waste of money. Plus, you must pay NY Mortgage tax at $2.175 per $100 for 1, 2 or 3 family houses and individual residential condo units securing $500,000 or more. That's about $39K additional during closing! For IO for the first 5-10yrs for a 1.8M loan, you're paying about $11-13K per month in interest payments.. that's at least $120K per year you're giving away! You're not going to be able to deduct all of your mortgage interests paid.

If you're placing your funds into a high-interest money market account at 5.25%, you're still at lost in 5-10 yrs. If you're able to invest your money elsewhere (stocks, mutual funds, etc), it may be profitable in the longrun.

#55 - NY Mortgage Tax... hmmm... so if the place was 499k instead of 1mil, there is no tax (sorry, I am not familiar with this tax)

In regards to the rest of your post... so you are saying you would put 100% down and not have a mortgage?

<$500K, you still have to pay mortgage tax at a rate of $2.05 per $100. If you do not take out a mortgage, you will not be responsible to pay mortgage tax. Any amount of loans will also be subjected to an origination fee by the lender (bank) that ranges from 0-3%. For example, you will be responsible for $54,000 origination fee (3%) by the bank for taking out a 1.8M loan. The fee is usually included in your loan amount. If you take out a 1.8M loan, the actual loan financed to you is 1.746M + $54K origination fee.

In addition to that, there are unavoidable fees. You are responsible to pay the mansion tax at 1% of purchase price where $1 million and over. If you are purchasing directly from the developer/sponser, there is also NY city real property transfer tax - 1% of purchase price up to $500,000 and 1.425% of purchase price over $500,000. You will also be new york state transfer tax at $4 per $1,000 of purchase price.

I would suggest that you sit down and learn about all of the costs for ownership. All properties will be subject to title insurance and title search/exam fee. For new developments that are purchased directly from the developer/sponser, you will be responsible for a transfer tax. A few new developments that were purchased by a private individual during construction phases for resale may also require you to pay a flip tax. There is also monthly real estate taxes. Most new developments will have an abated tax, in which your taxes will be very low (<$100) per month and increases 20% every 2 years for the 1st ten years. The tax will be non-abated after 10 years. If you are buying a condo, coop, condop, or loft, you will be subjected to monthly maintenance/common cost.

You really have to think about what will be in your best interest. Paying approximately $120,000 in interest to a bank or invest the $120,000 elsewhere to earn a profit in the longrun. I would suggest you talk it over with your personal financial advisor to create a plan that would be in your best interest.

I am doing IO (I also did no-doc, more on that later). My husband and I are buying a 1 bed, 1 bath condo and are financially convervative people. We were only willing to borrow 2x our annual HHI. And we prefer to keep our monthly housing costs below 20% of our monthly HHI. We really wanted a 2 bed/2bath, but can't afford it now. We know that we are only going to be in this place for about 5 years. I don't see any rush to pay off the mortgage. If we do stay in the apartment longer, we won't have any trouble paying the higher rate and principal payments.

No documentation loans are often called Liar Loans. But this is acutally an oversimplification. If you get a mortgage from a company with which you have othr financial relationships, documentation is not always necessary. I have my paychecks and bonus checks deposited in my brokerage account. I have 100% of my investments with my brokerage firm. My brokerage firm also writes mortages...seeing my paystub and bank statements is not really necessary.

question -- what does mortgage tax have to do with an I/O loan? Dont you pay this on the borowed amount on any loan? or is this comment relevant to just the "buy for $1M vs. mortgage" question?

Hmmm...

We are getting a bit lost in the details. #57, I appreciate your points, but the unavoidable costs are irrelevant to this disucssion, because you have to pay them regardless of whether you purchase via mortgage or not. Let me try to re-frame it:

Option 1 - Purchase outright
-Own $1M NYC home outright
-owe monthly maint only
-have $1M to invest elsewhere - assume you can match the stock market returns exactly

Option 2 - Mortage the purchase
-own $1M home via mortage (20% equity)
-owe monthly maint payment PLUS mortgage payment
-corresponding tax deduction for interest on mortgage
-have 1.75M to invest elsewhere (allocating 50,000 for the transaction costs #57 pointed out) - again, assume you can match stock market returns exactly

Which option would you choose and why?

#53 - I think Kyosaki would say do what you can to get out of the rat race, by getting enough passive income to offset your living expenses so that you dont have to work anymore. I dunno what Casey Serin would say cuz I have to admit I do not know who he/she is.

The answer may also depend on if you have current income and/or are subject to AMT and income taxes...