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AMERICAN CAPITAL
MORTGAGE, INC.
444 Galisteo Street, Suites B & C
Santa Fe, NM 87501
Toll-Free: (877) 663-4422
Direct: (505) 983-9222 or 988-4422
Fax: (505) 983-7988 or 988-3872
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Interest-Only Loans - Great for Cash Flow
(Originally published in Santa Fe Real Estate Guide / The New Mexican)
Many homeowners have asked what is the best method of improving their cash flow. “Interest-only” loans are now being offered by more national lenders and represent possibly the best cash-flow savings available.
Interest-only loans have traditionally been limited to home-equity loans. A minimum monthly payment of interest is required with principal reductions optional. Now interest-only loans are available for first mortgages either for a home purchase or a refinance of an existing loan.
A $300,000 adjustable loan at 5 percent with the usual 30-year amortization results in a monthly payment of $1,610 per month. The interest-only 5-year-adjustable carries a payment of $1,250 per month. Thus the homeowner has created a cash-flow savings of $360 per month or $21,600 after five years. This represents a 23 percent reduction in the monthly payment.
Some homeowners subscribe to the current theory that paying down principal on a home mortgage is not a sound financial idea because the after-tax cost (home mortgages are generally deductible from federal tax) of the mortgage is far below the return that even a conservative financial investment can achieve.
The estimated cost of a 5 percent mortgage for a homeowner in the 30 percent federal tax bracket is approximately 3.5 percent. Of course, please check with your CPA or tax adviser to confirm your tax savings.
The interest-only loan increases the borrower’s tax deductions and allows for principal payments whenever the homeowner’s budget allows.
One lender advertises the interest-only loan with benefits that include “qualifying the borrower for a larger loan amount, a substantially lower payment compared to a traditional fully amortized loan and potentially larger interest deductions on income tax.”
The interest-only payment period is normally limited to a fixed number of years (usually three to 10). After the interest-only period, principal payments are required.
Particularly homeowners who expect to be selling their home in a few years or investors buying an investment property may prefer an interest-only loan, and it may be very practical for second-home purchases as well.
Interest-only loans are not for all homeowners. Even though principal can be paid at any time some families do not need a cash-flow savings and prefer a 15-year fixed mortgage that requires them to pay a certain principal each month.
Interest rates are still at a historical low level and homeowners are refinancing to lower their payments. With the interest-only loan the payback period for closing costs is shorter because the reduction in payments for the prior mortgage is greater.
An existing $200,000 mortgage at 7 percent which is refinanced to a 5 percent interest-only loan will produce a $495 monthly reduction during the interest-only period. Closing costs can be approximately $3,200 or 1.7 percent of the loan amount. Thus, the closing costs, which are included in a new mortgage, can be recaptured in 7 months.