Interesting Facts About Interest-Only Loans

Defy Mortgage
Jul 11, 2023 • 2 min read
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Date The Rate, Marry The Property

Introduction

Curious about interest-only loans? In this blog post, we'll explore the ins and outs of interest-only loans, shedding light on their features, benefits, and considerations for borrowers. Here’s everything you need to know about how IO loans work and what to consider before applying for one. 

What is an Interest-Only Loan?

Interest-only loans (IO mortgages) are ARM loans that allow borrowers to pay only the interest on the loan for a set period of time, with fixed rates and no requirement for a principal paydown. Following that period, you can either refinance, pay the remaining balance in full or begin making regular monthly payments. 

These loans help by giving you the flexibility to pay the loan down as you see fit with the ability to manage your own cash flow as they have a smaller required payment.

How Do Interest-Only Loans Work?

There are two different periods that make up the borrowing term for an interest-only loan:

  1. Interest-Only Period: During this period, which can be up to 10 years, your mortgage payments will solely cover the interest portion. It's important to note that these monthly installments will not go towards reducing the principal balance or generating equity in your home. If building equity alone is your main goal you should consider paying the principal down as well, when most convenient with your cash flow. We offer this option at Defy Mortgage.
  2. Interest & Principal Period: Following the initial interest-only period and for the remainder of the term, you’ll make monthly payments towards the principal and interest. While you can make principal payments during the interest-only phase, once it ends, you must make combined payments. If that doesn’t work for you, you now also have the option to refinance so that you can “date the rate and marry the property” or pay the remaining balance in a lump sum.

The average 30-year mortgage is paid off in less than 10 years and according to the National Association of Realtors, most plan on staying in the property for 12 years. 

Who is Interest-Only Loan For?

These loans are perfect for the self-employed, and ideal for annual, quarterly or commissioned borrowers who want flexibility in principal reduction payments. 

They are also an excellent choice for borrowers who might have another investment opportunity (like real estate investors) or upcoming payments (like college tuition) and want to free up cash, for borrowers considering selling or refinancing within a short timeframe or for someone expecting to come into more money before the interest-only period ends. Because these loans are flexible, cash flow can be easily managed. If any of the above sounds like you, an IO loan might be a good option.

Benefits of Interest-Only Loans

  • Fixed rates and flexibility to manage cash flow discussed above
  • No requirement for a principal paydown, in turn, making monthly payments lower
  • Borrowers can minimize their payments if desired; that way, they can pursue other investments 
  • Pay only the interest on the loan for a set period of time (up to 10 years!)

Things to Think About When Considering an IO Loan

Consider your long-term goals: How will you reallocate the principal portion you would normally pay? Other investments, your business, other property, or some other opportunity? You may benefit from any home value appreciation whether you pay the principal or not. Some consider it like a rent payment with the potential for home appreciation increasing your overall wealth. 

Have a long-term plan/view: Understanding that at the end of the 10-year interest-only term, if the loan is still held, your monthly payments will become fully amortized.  As such, it is important, typically around year 5 of the note, to begin to watch rates (refinance) or to plan for what you will do if you still have the loan at the end of the interest-only term.

Pay attention to home values: Since most don’t make principal reduction payments during the interest-only period, if home prices are depreciating, your equity will be impacted and, depending upon your initial loan to value, it is possible that one could have difficulty with refinancing after the 10-year period. 

Defy’s Interest-Only Loan Highlights

  • Loan amounts up to $10M+
  • Up to 85% LTV 
  • Interest-only fixed rates of 5/7/10 years
  • No requirement for a principal paydown
  • 30-year or 40-year loan amortization
  • Primary, second, and investment properties

At Defy Mortgage, we are committed to providing customized loan solutions that cater to your specific needs. Whatever your situation may be, we are dedicated to assisting you every step of the way. Explore our website to learn more about your loan options and how we can assist you. Interested in tips and tricks associated with Interest-Only loans? Check out our most recent Tip Tuesday on Linkedin

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