Question:

What are the features of an interest only mortgage program?

Answer:

An interest only mortgage program is simply a fixed or adjustable rate home loan offered with Interest only payment option for limited time.

General IO Mortgage Program Characteristics

  • A standard 30-year FRM loan at 6.25% will be offered with 10-year IO period with slightly higher rate, meaning you are allowed to pay monthly interest only and no principal for 10 years.
  • Fully amortizing payments will be required afterwards for the remaining 20 years of the mortgage, unless the loan is repaid, refinanced or the house is sold.
  • If the IO option is used every month, the loan balance will remain unchanged and at the end of the IO term, you will still owe whatever amount you borrowed.
  • Interest-only and Option ARM loans both have interest only monthly payment option.

Pure Interest Only loans do not allow negative amortization unlike Option ARMs.

An interest-only home loan will never require that you pay more than you borrowed. During the life of the loan, you are paying all the due interest, no interest is deferred and the loan balance won't grow.

Be careful with Option ARM loans. They go with interest-only option but they are Neg Am loans. When the flexible payment plan expires, you will owe more than you borrowed, especially if you used up the minimum payment option and never paid anything towards principal.

Why is it important to distinguish between IO and Option ARM home loans?

Those loans are particularly popular now as consumers tend to get better informed and likely to take more financial risks, especially in the urban areas. It is exactly in high-cost metropolitan areas that IO and Option ARM mortgages make most sense to take, as home values are higher and homes are difficult to afford when you are just getting out of college, or in the beginning of your career.

However, these are loans either advertised as an easier way to get more house and that exposes many borrowers to unnecessary risks; or certain home buyers are outright discouraged from taking any such kind of a loan.

Most Important Differences between Interest-Only and Flexible Payment (Option ARM) Mortgage Loans

Interest only loans are safer loans. They are not as safe as pure fixed rate loans, but most of them are fixed rate mortgages with Interest-Only payment option. Pure IO adjustable rate loans are available, too, but on a rather limited basis.

The interest rate on IO FRM loans, although somewhat higher, usually stays fixed for the entire IO term - 2 to 10 years.

Option ARMs, on the other hand, do have the interest-only option but they allow negative amortization, and the rate is not going to stay low for more than several months, unless you are getting a Hybrid Option ARM. Those are very new loans and are safer than pure Option ARMs and more flexible than Interest Only mortgage loans, combining payment flexibility with fixed interest rate for 3 to 10 years of the loan.

Mortgage rates hit their lowest since 1955. Ask the home loan experts we recommend Quicken Loans how to take advantage of them.
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