Interest Only Mortgage Products
With interest only home loans, you make only interest payments during an initial period of the loan term (usually 3 to 15 years). During the initial "interest-only" period, your payment will not include any repayment of principal. So, the loan balance remains unchanged. Once the initial term expires, the loan will become a fully amortizing loan based on the remaining term, and your payments will include interest and repayment of principal. This means that your interest rate and monthly payments will be lower during the interest only period but will increase when that period ends. The increase is generally significant so be prepared to pay a larger payment once the interest only period is over to prevent what is sometimes called "payment shock." While you're only required to make interest payments during the initial "interest-only" period, you can choose to pay more than the interest to help lower your principal.
If your interest only loan is also an adjustable rate mortgage, the interest rate on your loan is not fixed and may increase over time according to a formula – typically, a base interest rate (index) plus a certain percent (the margin). However, the initial interest rate may not be based on the index used for later adjustment. Future increases/decreases in your interest rate will be limited by terms of the note which will include limits on the first interest rate adjustment, subsequent interest rate adjustments, and lifetime interest rate adjustments. At the end of the first adjustment period, your interest rate may increase significantly even if the index value stays constant. Your interest rate and monthly payment could possibly increase even more if market rates rise and the index value increases.
We offer a 5, 10 or 15 year interest only home loan option on our 30-year fixed rate mortgage and our 3/1, 5/1, 7/1 and 10/1 Adjustable Rate Mortgages (ARMs). The following chart compares a traditional fixed rate mortgage with a 5 year interest only ARM and a 5 year fixed rate interest only mortgage. The illustration is based on a loan amount of $200,000 with a term of 30 years:
| Traditional Fixed Rate Mortgage | 5-year Interest Only Arm (initial rate 7%; maximum rate 12%) | 5 – Year Fixed Rate Interest only Mortgage (initial rate 7%) | |
|---|---|---|---|
|
Required Monthly Payments (Includes $200 per month for real estate tax and insurance escrow) |
|||
| Years 1-5 | $1,531 | $1,367 | $1,367 |
| Year 6 – if rates don’t change | $1,531 | $1,614 | $1,614 |
| Year 6 – if rates rise 2% | $1,531 | $1,878 | $1,614 |
| Year 8 – If rates rise 5% | $1,531 | $2,294 | $1,614 |
| Effect on Loan Balance and Home Equity | |||
| After 5 Years How much will you owe? | $188,263 | $200,000 | $200,000 |
| After 5 Years, How much home equity have your loan payments built? | $11,737 | $0 | $0 |
Consider an interest only home loan if:
- Your main income is from infrequent bonuses and/or commissions
- You're prepared to handle an increase in payments once the interest only period ends
- You plan to invest the savings you receive on the difference between payment amounts on the interest only term and the remaining term of your loan, and you're confident that the investment will make money
For detailed information on how ARMs work, review the Consumer Handbook on Adjustable Rate Mortgages which is a joint publication of the Federal Reserve Board and the Office of Thrift Supervision.
