Are Interest Only Loans Bad?

      In my six years in the mortgage business, I have often encountered potential borrowers who are afraid of interest only loans. In a society built on fear, this does not surprise me. To alleviate the fear, let's start with the basics. With a traditionally amortized loan, the borrower makes a principal and interest payment each month. With an interest only loan, the borrower is just required to make an interest payment each month. That monthly interest payment is based on the remaining principal balance of the loan.

       Here’s the key. As a borrower, you can make an additional principal payment if you choose. You could actually pay your interest only mortgage just like a fully amortized loan. Where the two types of loans differ is that with an interest only loan, the more principal you pay off, the lower your payment goes each month. If you were to pay down the principal on a fully amortized loan, your balance would go down, but your monthly payment would stay the same. You may actually like that when you make additional principal payments on your interest only loan that the payment goes down.

      A few years ago I had clients who had a real problem. They thought they had cut their payment in half by prepaying their fully amortized principal and interest loan. They paid the mortgage balance down by half and expected that their monthly payment would go down the same as well. However, it did not change. On a fixed principal and interest loan the payment schedule is set for the term of the loan at the closing. My clients had bought a new home before their old one had sold. They figured that they would take the proceeds from the sale and pay down their new home mortgage to drop their monthly payments to a comfortable level. They made the principal reduction payment after the sale of their old home, got next month's mortgage statement and had a panic attack. The balance of the mortgage went down correctly, but their payment did not. Perhaps the original broker who prepared this mortgage didn't get a clear picture of what these clients were trying to accomplish. If the borrowers had understood the mechanics of their mortgage product, they would have only had to do a mortgage once. By the time I began working with them, they were fuming about the incompetence of the other broker. I explained to them how they could have avoided the problem altogether. It doesn't take much to cause a borrower a major inconvenience not to mention expense, by not knowing mortgage products and fitting them to the borrower's needs.

       It is important to do your homework and understand what you are doing. Don't sign any mortgage document unless you are clear about what you are signing. Also be very clear with the loan officer that is doing your mortgage about what you are trying to accomplish. To be fair to the mortgage broker discussed earlier, the broker may not have been clear on what the borrowers' intentions were when the loan application was taken. It is up to you as the borrower to be clear. A bad real estate situation will hit you hard if you are not looking. Be an informed consumer. Go to GetPreQualified.com for additional information regarding obtaining a mortgage and buying a home. The brokers of GetPreQualified.com work with you to find the right mortgage product for your home buying situation.