It’s very simple to calculate an interest only payment without the need of a financial calculator.
Loan amount X rate / 12 = monthly payment
We all agree that Interest only loans have had a bad reputation since 2008. This is largely due to them being overused and borrowers using them to buy homes that they really couldn’t afford. Back then, the mentality was “home prices always go up.” Needless to say, the last decade disproved that way of thinking and taught everyone a very important lesson. So, let’s take a look at the use of interest only loans today.
What’s the benefit of an interest only loan?
Customers who have income that fluctuates typically prefer the benefits of an interest only mortgage. There are many commission employees who have paychecks that go up and down drastically from month to month. This type of individual can benefit from an I/O loan because the payment is lower than a 30 year fixed rate payment. The smaller payment can provide some breathing room when cash flow might be a low.
But the principal amount is never getting paid on this type of loan.
That’s actually how a lot of people got in trouble with these loans. It’s important to be disciplined and have a plan for paying down the principal. Again, think of somebody whose paycheck fluctuates. When they have a good month, they can make extra principal payments on the loan. Once the principal starts getting paid down, all future payments are adjusted based on the new lower balance. This drops the minimum payment or interest only payment going forward.
Here is an example of the monthly payment dropping after a principal payment:
|MONTH||BALANCE||RATE||I/O PAYMENT||EXTRA PAYMENT (PRINCIPAL)|
Now there are a few other catches with Interest only loans.
They’re usually an ARM and the rate becomes adjustable after the initial period. Click here to learn how ARMs work. There was one loan where an interest only was a fixed rate. The interest only period was for the first 10 years and the loan converted to a 20 year fixed rate (principal and interest) loan based on what the balance was at that time. So unless adequate principal payments were made during the first 10 years, the monthly payment would increase since the monthly payment then includes principal and it was a 20 year payment term. This particular loan was very popular since it gave the benefit and peace of mind of a fixed rate with 10 full years of the flexibility of interest only.