What is an Interest Only Loan?
Simply put, an Interest Only (IO) Loan is where only the Interest on the amount borrowed is paid, for the life of the loan. The final payment is the lump-sum of the principal.
There are however variations of IO loans, such as Adjustable Rate Mortgage (ARM); where during the, the interest rate is fixed. After that initial term, the interest rate adjusts (typically increasing), and could possibly re-adjust (increase or decrease) annually based on product parameters and market conditions.
Another variation to IO loans is Paying the Principal. Depending on compensating factors, lenders can require borrowers to make principal & interest payments throughout the life of the loan, or only on the remaining life, after the first 5 to 10 years.
What are the Benefits of Interest Only Loans?
- IO loans allow for people to afford more home now.
- IO loans are a great option for Investment Properties and Investors, or Individuals whose job or Military assignments have them move every few years.
- With the initial payments of an IO loan being low, borrowers are given the ability to Save, Invest , or repurpose their money NOW, where they could get a higher rate of return.
What are the Disadvantages of Interest Only Loans?
- Rising mortgage rates increases risk if it’s an ARM.
- Many people spend extra money instead of investing it.
- Many cannot afford principal payments when the time arrives and many are not disciplined enough today extra toward the principal.
- Income may not grow as quickly as planned.
- The home may not appreciate as fast as the borrower would like.
What are the Qualifying Requirement for Interest Only Loans?
Like most other types of Loans, Qualifying Requirement for IO Loans, depend on the:
- Loan-to-Value (LTV) Ratio. How much do you want to borrower and what is the value of the property?
- Debt-to-Income (DTI) Ratio. Your total recurring monthly debt divided by gross monthly income.
- Credit Worthiness of the Borrower(s). Past and current Debt repayment history and FICO Score.