Does anybody have an opinion on using an interest only loan on their primary residence? The logic behind this is that by using an interest only loan you will be able to use the savings to invest elsewhere and be able to write off the interest to save even more....or so I have read. In my situation, we will probably not stay in the next house we are going to buy for more than 3 years. So I was thinking we could just refinance at the time we did have to start paying principle or sale the home. I would love opinions on using this strategy versus using conentional 30 yr fixed financing.
The idea here is to invest the savings into another investment vehicle. If you can get a better return (net of taxes) then an IO loan COULD make sense. If you are just going to spend the savings then it doesn’t make sense.
If you are only going to be in the house for a short time it can make sense. In the first few years you do not pay the mortgage down very much anyway. It depends on what you do with the money you save. If you invest it elsewhere it could be a smart thing to do but if you are using interest-only as a way to buy a house you really can’t afford it isn’t good. So many people who did that as a way to cash in on the real estate boom are hurting now.
Good point. I was just reading an article on that very issue this morning. Is there really a significant savings between conv. and interest only? I have read that you will only save approx. $200 a month with a principle of $200k (which is about 10-20k more than what I want to spend)....the higher the principle the more you save. I have not found an ammortization calculator that does interest only loans. Do you know of one?
Interest only loans do not amortize, you are only paying interest. Your balance will always be what you started with.
Example:
200,000 @ 6% interest only
Payment = 200,000 x .06 = 12,000 / 12 = 1,000/month
The balance of the loan will always be 200k because you are only paying interest. To figure the monthly payment just multiply the loan amount by the interest and divide by 12.
Vs. a payment of $1199.10 for 200K, 6%, 30yr loan. With the 30 year loan, your balance after three years would be $192,168 vs. $200,000 with the IO loan.
With an IO loan, you're really betting on appreciation. If you're really planning to sell in three years, and you get 3% appreciation, you'll be able to sell it without having bring money to the table (200K, 3%, 3 years = $218.5K. Closing costs about $17.5K) If you get 10% appreciation and the house is worth $266K, then the $9K paydown isn't very significant.
Consider, though, and falling or flat prices are, IMHO, a very real possibility over the next few years. I bought a house in Bakersfield CA in 1995 for $239.5K. I sold it in 1999 for $239K, but with about 6K in concessions to the buyer. I believe the people we bought it from paid about $280 a few years before we bought it. That house was STILL worth $240K in 2003, although its worth double that now. That's eight years with ZERO appreciation. What will it be worth in three years? Who knows, but my money's on it being worth less than it is now.
If that was to happen with your IO loan, you would have to bring a big pot of money to the table to sell. Or, stay in your house and hope the price comes back up. You probably wouldn't be able to refi without putting money on the table. At least with an amortizing loan your paying down the loan. Slowly at first, but faster over time.
The idea here is to invest the savings into another investment vehicle. If you can get a better return (net of taxes) then an IO loan COULD make sense. If you are just going to spend the savings then it doesn’t make sense.
That was the plan...to invest in more RE. I am pretty thrifty and so is my wife, so spending the savings on junk wasn't even a consideration. So, would the whole monthly payment (the interest, taxes and insurance) for the house be tax deductible? This year it wouldn't really help us out, but I was wondering if we could carry the deductions over to next year?
I'm still not sure if I/O or ARM's are good for short holds(flipping) where you'll sell before the low int. rate changes; or the market drops.
Instead of putting the money into principal, it can be invested; then there's that money - and then some - to bring to the table. If your house depriciates, does it really matter how much your paying down the principal?
I could be completely wrong here but I thought I remeber reading about Interest only loans and people having ownership problems.
Lets say you lose your job and can't make payments or something else horrible happens. Now your are stuck in a foreclosure process....but since you aren't paying the principal down...you don't really even "own" anything. I think it is alot easier to the property to be taken away or claimed and you get left hi and dry because of this interest only. Worst of all you aren't building any equity...which is one of the biggest benifits to home owning.
I could be 100% wrong, I know I don't have all the details but in general its a fairly risky type loan.
If you are absolutely certain about being out of the house in 3 years...an ARM might be a better option, as someone else suggested. You are building up equity because you are making payments toward the principal.