An interest only loan is a type of mortgage where you only pay the interest on the loan for a set period of time, usually 5-7 years. After that period is up, you then start paying off the principal on the loan as well. Interest only loans can be a great option for people who want to buy a house but don't have enough money for a down payment. In this blog post, we will discuss all the basics of interest only loans so that you can decide if it's the right option for you!
What Is an Interest Only Loan Table of Contents
What Is an Interest Only Loan?
An interest only loan is a type of loan that allows you to pay only the interest for a certain period of time. This can be an attractive option if you are looking to lower your monthly payments or want to keep your payments the same while you invest extra money elsewhere.
The downside of an interest only loan is that you will ultimately have to pay back the full amount of the loan plus interest. This means that if you don't carefully plan how you will use this type of loan, it can end up costing you more in the long run.
What Are The Advantages of Interest Only Loans?
There are a few advantages of interest only loans. One is that you can make smaller payments each month since you're only paying the interest on the loan. This can free up some cash flow each month which can be helpful if you're tight on money.
Another advantage is that it can help you qualify for a larger loan. Lenders typically look at your debt-to-income ratio when determining how much to lend you. If your payments are lower, this ratio will be lower and you may qualify for a bigger loan.
The last advantage is that it may help you pay off your loan faster. While most loans are amortized over 30 years, with an interest only loan you have the option to make higher payments
What Are The Disadvantages of Interest Only Loans?
There are a few disadvantages of interest only loans to be aware of as well. One is that you're not actually paying down the principal of the loan each month. This means that at the end of the loan term you'll still owe the full amount of the loan.
Another disadvantage is that you may end up paying more interest over the life of the loan if rates go up. With a traditional loan, your payments stay the same but with an interest only loan, your payments will increase if rates go up.
Lastly, if you don't have enough discipline to make higher payments when you can, you may find yourself in a tough spot when the loan term ends and you have to start paying down the principal.
Who Can Qualify For Interest Only Loans?
In order to qualify for an interest only loan, you'll need to have a good credit score and a steady income. Lenders will also look at your debt-to-income ratio to make sure you can afford the payments.
If you're self-employed, it may be harder to qualify since lenders like to see a steady income. However, there are some lenders who specialize in loans for self-employed borrowers so it's worth shopping around.
How Do Interest Only Loans Work?
Interest only loans work by giving you the option to make lower payments each month. The downside is that you're not actually paying down the principal of the loan which means you'll still owe the full amount when the loan term ends.
It's important to remember that with an interest only loan, your payments will increase if rates go up. This can make it difficult to afford your payments if you're not prepared for it.
Interest Only Loans vs Traditional Mortgage
The biggest difference between an interest only loan and a traditional mortgage is that with an interest only loan, you're only paying the interest for a certain period of time. This can be attractive if you want to lower your monthly payments or keep them the same while you invest extra money elsewhere.
The downside is that you will ultimately have to pay back the full amount of the loan plus interest. This means that if you don't carefully plan how you will use this type of loan, it can end up costing you more in the long run.
What Is the Point of an Interest-only Loan?
The point of an interest-only loan is to give you the option to make lower payments each month. This can be helpful if you're tight on money or if you want to use the extra cash for something else, like investing.
Just remember that you will still owe the full amount of the loan plus interest when the loan term ends. If rates go up, your payments will also increase which can make it difficult to afford your payments.
Who Should Get an Interest Only Loan?
Interest only loans can be a good option for borrowers who are self-employed or who have a good credit score and a steady income. Just be aware of the risks before taking out this type of loan.
How Long Can You Have an Interest-only Loan?
Interest only loans typically have a term of five to seven years. This means that you will only make interest payments for that time period. After the interest-only term ends, you will then have to start paying down the principal of the loan in addition to the interest.
What Happens if You Can't Pay an Interest Only Loan?
If you can't pay an interest only loan, you may end up in foreclosure. This is because with this type of loan, you're not actually paying down the principal each month. If you can't make your payments, the lender may foreclose on your home.
It's important to be aware of all the risks before taking out an interest only loan.
How to Apply for an Interest-only Mortgage?
If you're considering an interest-only mortgage, there are a few things to keep in mind. Here's how to apply for an interest-only mortgage:
First, when you're applying for any kind of mortgage, it's important to shop around and compare rates from different lenders. This is especially true for interest-only mortgages, because the terms can vary significantly from one lender to another.
Once you've found a few lenders that you're interested in working with, the next step is to get pre-approved for a loan. This will give you an idea of how much money you'll be able to borrow, and it will also help narrow down your options.
When you're ready to apply for a loan, you'll need to provide some documentation, including proof of income and assets. The lender will also want to see your credit history, so be sure to have that information handy.
Once you've been approved for a loan, you'll need to make sure that you're comfortable with the terms. Make sure you understand how much money you'll need to repay each month, and how long you'll have to make payments.
If everything looks good and you're ready to move forward, then it's time to sign the paperwork and get started on your new interest-only mortgage!
What Are The Different Types of Interest Only Loans?
The three main types of interest only loans are fixed rate, adjustable rate, and balloon.
A fixed rate interest only loan has the same interest rate for the entire term of the loan, typically 30 years. The monthly payment is calculated so that you will pay off the principal balance at the end of the term.
An adjustable rate interest only loan has an introductory period where the interest rate is lower than it will be after that period. After the intro period ends, your interest rate and monthly payments will increase.
Interest only loans can be a good option if you are expecting a large influx of cash in the near future, such as from the sale of another property. They can also help keep your monthly payments lower during the first few years of homeownership. However, because you're not paying down any principal during that time, you'll end up paying more interest over the life of the loan.
What Fees Come With Interest Only Loans?
Origination fees, private mortgage insurance, and appraisal fees are common with interest only loans.
An origination fee is a charge by the lender for processing the loan. This fee is typically a percentage of the loan amount, and it can vary from one lender to another.
Private mortgage insurance (PMI) is required if you're putting less than 20% down on your home. This insurance protects the lender in case you default on your loan. premiums are usually paid monthly, and they can range from 0.15% to as high as 0.45% of the loan amount annually.
An appraisal fee is charged by the lender in order to have an appraiser assess the value of your home. This fee is typically a few hundred dollars, and it's generally paid at the time of application.
Interest only loans can be a good option for some borrowers, but it's important to understand all the risks before taking out one of these loans. Be sure to shop around and compare rates from different lenders, and make sure you understand all the fees involved. If you're comfortable with the terms, then an interest only loan can help you save money during the early years of homeownership.