Anyone that reads my blog knows that in general I am not a fan of Interest Only (IO) loans. I have said before that an IO loan is like putting your mortgage on a credit card. But on a refinance it may make sense for a few reasons. If you have already built a lot of equity it may make sense. And if you are more interested in savings than equity building. And if you know you are not going to live in the property forever so have no interest in getting the mortgage paid off.
A client story
I had a client tell me recently that they would definitely be out of their house within 5 years. And they didn’t think they’d have trouble selling it. So they thought a 5 year IO ARM would be perfect. I asked them the details of their loan:
1. When did you buy the home? bought it in 2007, refi in 2010, another refi in 2011
2. What is the current rate on the 1st trust mortgage? 5 year ARM at 3.25%
3. Do you have a 2nd trust/equity line, and if so at what rate? no
4. What did you originally pay for the home? $570,000
5. What do you believe the home to be realistically worth now? $600,000
6. What is the balance of the loan amount/s? $400,000
7. Is this home your primary residence, a rental property, or a vacation home? primary residence
8. What type of property is it, condo, single family detached, rowhome, 2 unit, 3 unit, or 4 unit? SFD
I gave her the following options, so she could compare:
400k new loan @ 4.125% 30 year fixed = $1938/month
400k new loan @ 3.75% 30 year fixed = $2908/month
400k new loan @ 3.25% 30 5 Year ARM = $1740/month
400k new loan @ 3.50% 5 year IO ARM = $1166/month
The lowest payment
So you can see the IO ARM offers the lowest payment, by far. The client already had $200,000 of equity built up. They were more interested in saving the almost $600 a month the new 5 Year IO ARM offered over her current regularly amortized ARM. Even though the rates are a bit higher on an IO ARM it seemed to make sense.
And that brings me to the conclusion. Remember that IO ARM’s are not in favor in the mortgage industry. The industry got burned on IO ARM’s a lot more than other loan products. Now when you get an IO ARM you will notice:
You have to qualify at the fully amortized payment, not the IO payment.
They only offer lower Loan-To-Values, which requires more down payment/equity.
They come with higher rates than other ARM’s.
They have higher credit score requirements.
But, if you are after savings and have a lot of equity, then the IO loan may make sense. I still believe to purchase a new home on an IO loan is like putting a house on a credit card. But if you have a 40% down payment, maybe that is OK too? Maybe you already have enough equity?
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