getting a home loan on Credible.com
Are interest-only loans the same as adjustable-rate mortgages?
An adjustable-rate mortgage (ARM) periodically adjusts your interest rate to reflect market conditions. This stands in contrast to fixed-rate mortgages, which lock in a single rate you’ll pay across the entire life of the mortgage.
| Good to know: An ARM can save you money if interest rates decline in the future. However, you may end up paying more if interest rates increase. |
Many lenders structure interest-only loans as adjustable-rate mortgages. However, not all adjustable-rate mortgages are interest-only loans, and not all interest-only loans are adjustable-rate mortgages. An ordinary adjustable-rate mortgage will require you to make regular payments on the principal, starting with your initial loan payment.
Advantages of interest-only mortgages
Interest-only mortgage loans can provide certain advantages to financially savvy homebuyers. Some of the benefits for borrowers who take out an interest-only mortgage loan include:
- Higher home-purchasing limits: You can qualify for a higher purchase limit than conventional loan products would allow for.
- Lower monthly payments: Your payments are lower on the front end of mortgage repayment.
- More cash flow: Having lower payments frees up cash for other investments and financial needs.
- Tax benefits: You can deduct mortgage interest (up to $1 million) on your tax return.
Disadvantages of interest-only mortgages
Interest-only loans aren’t for everyone. If you choose to take out an interest-only mortgage, plan for the following drawbacks:
- Low payments are temporary. The monthly payment on an interest-only mortgage is only lower during the interest-only period.
- Your rates may increase. As an adjustable-rate mortgage, your rates may increase over time — it can happen as often as every month or as infrequently as every five years.
- You won’t build equity. There’s no home equity built up when making interest-only payments.
- Your home value could decrease. If your property depreciates, it may not be worth as much as the remaining principal owed on the mortgage.
- You’ll pay more in the long run. Expect to pay more than you would with a traditional 30-year fixed-rate mortgage.
How to get pre-approved for an interest-only mortgage loan
Some lenders may allow you to get pre-approved for an interest-only mortgage. To get pre-approved, the lender will perform a soft credit inquiry for a snapshot of your credit. They may also inquire about financial information, such as your monthly bills, your income, and your job status.
| Good to know: Pre-approval does not guarantee that you will be approved by a lender. You must apply for a mortgage and meet the lender’s credit and other underwriting requirements to qualify for a loan. |
Interest-only loans are not ideal for borrowers with below average credit. Lenders take on greater risk because you won’t contribute to the mortgage principal for up to a decade from the loan origination date. As a result, lenders look for well-qualified borrowers with a minimum credit score of 700 or higher, a debt-to-income (DTI) ratio of 43% or lower and a down payment of at least 20%. However, standards vary among lenders, so you’ll want to shop around.
Alternatives to interest-only mortgage loans
Interest-only mortgage loans are a niche financial product, and other mortgage products may better suit your needs. Before you take out an interest-only mortgage, check out these alternatives first.
Conventional fixed-rate mortgage
A fixed-rate mortgage features fixed interest rates that last for the life of the loan, protecting you from rising interest rates (and you could always refinance to take advantage of falling rates). Monthly principal and interest payments also stay the same over the repayment period. Conventional mortgage loan terms typically range from 10 to 30 years.
FHA loan
FHA loans are mortgage loans available through approved lenders backed by the Federal Housing Administration (FHA). Because the FHA covers mortgage insurance on the home, FHA loans are generally easier to qualify for and allow for lower down payments and closing costs. With an FHA loan, your down payment can be as low as 3.5% of the purchase price.
FHA loans come in a variety of forms. You can choose between fixed and adjustable-rate mortgages. Section 245(a) FHA loans work similarly to interest-only loans, and this loan type gradually increases your payments over time. However, the two loan types differ in that section 245(a) loans require you to pay toward the principal immediately, albeit at a lower initial rate.
Hybrid mortgages
Hybrid mortgages combine aspects of fixed-rate and ARM mortgages. With a hybrid mortgage, you’ll commit to a fixed interest rate for a set period, after which the interest rate will adjust to market conditions.
Because hybrid mortgages often offer low initial rates, they may suit your needs if you anticipate selling your home before the interest rate adjusts. You may also find a hybrid mortgage beneficial if you believe interest rates will drop in the future.
Related: Learn more about getting a home loan on Credible.com
Source: nypost.com