Interest-Only Loans versus the 40-year

Borrowers who are looking to save money on their monthly mortgage payments, or who are looking to qualify for properties which are just beyond their reach when applying for a standard 30-year fully-amortized loan, have several options open to them.

Two common options are an interest-only loan and a 40-year fully-amortized loan. Either loan will allow borrowers to qualify more easily than an conventional 30-year fully-amortized loan, and bother loans offer lower monthly payments, at least initially

So which is better?
It depends on how long you plan to live in the home and on your tolerance for risk.

Clearly the interest-only loan involves a larger degree of potential risk. However, depending on where you live and your perception of the housing and interest markets over the next five to 15 years, you may find the risk acceptable.

An interest-only mortgage loan is generally an added option to a standard 30-year mortgage loan. With the interest-only option the borrower is allowed the option of paying only interest charges (and nothing toward the principal of the loan) for the first five years of the loan, or in many cases for the first ten years or even for the first 15 years of the loan. Once the “honeymoon” is over the interest-only loan converts automatically to a fully-amortized loan for the duration of the 30-year loan life.

Typically when the loan converts to a fully amortized loan, the monthly payments can be more than double what you were used to making.

Often people taking out an interest-only loan intend to sell the property just before the loan conversion period. One of the gambles is that interest rates and property liquidity at the time you need to sell will allow for a quick and profitable sale. There is, of course, no guarantee, though, of this definitely occurring.

The other option is to take out a 40-year fully-amortized loan. Like the interest-only loan, the monthly payment on a 40-year fully-amortized loan will be less than the payment on a fully-amortized 30-year loan, but unlike the interest-only loan you will pay-down a small portion of your principal each month and so increase your equity monthly with a 40-year fully-amortized mortgage.

If your monthly payments are a problem, you should check out both the interest-only loan as well as the 40-year fully-amortized loan and see which is better for your situation.