Interest Only Portfolio Loan Options
What We’ve Learned
Interest only loans were very popular at one time, and were mostly associated with what are now called toxic or subprime mortgages.
Now that we are finally returning to a normal real estate and mortgage market, it’s good to see that lenders are making a responsible effort to bring back more creative lending programs.
One of the things you have to realize is that there is no such thing as a toxic, or subprime loan; There are only toxic people that misrepresent those loans, and uninformed borrowers that put themselves into a risky situation without knowing all of the facts.
Creative loan programs carry no more risk than any other loan program. As a matter of fact, the “new” creative programs on the market today are much more conservative than traditional financing in terms of qualifying.
Is Interest Only Right for You?
Interest only loans are often referred to as sub-prime, or toxic loan program, when nothing could be further from the truth. Having the ability to pay only interest on a home loan is a convenience that many buyers and owners use responsibly.
An interest only loan is similar to how a Home Equity Line of Credit (HELOC) works. HELOC’s have been around for many, many years, and nobody ever called them sub-prime.
If you are using an interest only loan, it simply means that you have the ability to make a minimum monthly payment that covers the interest due on the loan, without paying down the loan balance. You are not restricted from paying down the balance of the loan, you just have the option of not doing so.
There are many reasons why you would want to do this, which include fluctuations in your work schedule, or seasonal income. Teachers are a great example of someone that may only work 9 or 10 months out of the year, and may need a little extra breathing room during the summer months.
If you know this isn’t going to be a home that you will retire in, Interest Only is great leverage to build equity in your home while you save, and prepare to buy your next home.
If you know that you will be moving, or switching jobs in the near future, and Interest Only loan allows you to save money, while earning equity, and benefiting from the tax benefits of homeownership.
Fixed Rate to Adjustable Rate Mortgage Loan
The most common type of interest only mortgage loan is attached to an adjustable rate mortgage that will be fixed for 5, 7, or 10 years. During the fixed rate period, there are no adjustments to your payment.
Once the fixed period is over, your loan can adjust either up or down, based on the terms of the loan. In most cases, this adjustment will only take place once a year, and you will have plenty of notice so that you can prepare for either a higher, or lower payment for the next year.
Interest Only Period that Becomes Fully Amortized
The fixed rate period of an Interest Only adjustable mortgage does not necessarily mean the end of the interest only period. Most of these loans are structured so that a minimum interest only payment is allowed for the first 10 years of the loan.
Even if your interest rate is only fixed for 5 years, you may continue to pay interest only for 10 years. The shorter the fixed rate period, usually the lower the interest rate you will pay. You may also find that the fixed rate period has a lower interest rate than your it would be if it was adjustable from the beginning.
Most home equity lines of credit are interest only for the first 10 years and become fully amortized for following 10 years. Most Interest Only first mortgage loans are 30 year loans, with a 10 year interest only period, that converts to a fully amortized principal and interest payment for the remaining 20 years of the loan.
If you’re doing the math in your head, you’re right – there will be a big jump in your payments if your principal and interest payments are paid out over 20 years, instead of 30 years. As I discussed previously, you wouldn’t necessarily take out an interest only loan if plan on paying off this mortgage.
What to Expect When Applying for an Interest Only Loan
If you think that you applying for an interest only loan means that you are qualifying for a lower payment, you would be wrong. You have to qualify as though you are paying principal and interest on the fully adjusted loan, not the lower fixed rate that you might start with.
As these loans are being introduced back into the market, you can expect that they are a little harder to qualify for. By reducing the risk through the credit and equity requirements, it also allows these programs to be more lenient and flexible in other areas.
Common qualifying guidelines include:
- Higher FICO requirements – 680 or more
- Higher Equity requirements – 20% downpayment (or equity)
- Debt to Income Ratio up to 50%
- Full documentation only – income and assets
- Condominiums allowed
- Loan amounts up to $3,000,000
- Cash out allowed up to $1,500,000
- Foreign Nationals allowed
Responsible Lending for Responsible Borrowers
Interest only loans are a great option for informed and educated borrowers that understand the risk, and meet the requirements for qualifying for this creative financing option. These programs may also be a little more expensive than simply taking a conforming or high balance Fannie Mae or Freddie Mac loan.
Discuss your goals with your mortgage lender, and determine if an interest only home loan is right for you. This is not a loan option for everyone, but when it’s right for you, it’s a great option that’s been a long time coming.