[SoccerDude28]

Hi everyone, I need your help, so I hope anyone can help me.

I am looking to buy a 2 bedroom condo, and I am really confused whether to buy it using a traditional mortgage, or an interest only loan.

Can anybody explain to me what's the difference between the 2, and which is better?

[SakSquash]

Originally Posted by SoccerDude28

Hi everyone, I need your help, so I hope anyone can help me.

I am looking to buy a 2 bedroom condo, and I am really confused whether to buy it using a traditional mortgage, or an interest only loan.

Can anybody explain to me what's the difference between the 2, and which is better?

My sister is coming tomorrow (I think), she's a real estate agent, if you still haven't gotten your answer, i'll ask her about it and let you know what she said.

[SoccerDude28]

Originally Posted by temporaryscars

My sister is coming tomorrow (I think), she's a real estate agent, if you still haven't gotten your answer, i'll ask her about it and let you know what she said.

Thanks man. Really appreciate it.

[Jen]

Traditional loan, say you pay $1000 a month. At first, $999 of that will go to interest and $1 to principal, and by the last payment, probably $1 to interest and $999 to principal But the interest and the principal both get paid by you.

An interest-only loan is just what it says: you only pay the interest. In exchange, you get a lot lower of a monthly payment, but meanwhile your principal stays exactly the same. This would be a good deal for an investment property where you plan to turn it around quickly for more than you paid but not such a good deal for your family home.

[gillyruless]

Jen is right, SD. You do not want to take a interest only mortgage on your house other than a few limited cases that Jen listed. On a primary residence, the only benefit of a interest only loan is that your monthly payment will be lower but you will not be increasing the equity of your house at all. Let's say you own your house for thirty years, if you have a traditional mortgage, you will have pais off a traditional 30 year mortgage and will own the house out right. On an interest only loan, you still owe the principal amount. Your only equity will be the down payment you made on the house.

If you will be selling the house in near future and you do not think that the housing market will not suffer a down turn, getting interest only loan might not be so bad as in the beginning on a long term mortgage very little of your monthly payment will go towards paying off principal. Most of it will go towards paying interest. Play around with a good amortization calculator like this one, http://ray.met.fsu.edu/cgi-bin/amortize , to see what I mean.

Here's an illustration. For a 30-year mortgage of $200,000 @ 6% annual rate, your monthly payment will be $ 1199.10 (this is for purely debt service and doesn’t include items such as tax, insurance, association fees etc). For the first year your amortization schedule will be:

Pmt Principal Interest Cum Prin Cum Int Prin Bal
1 199.10 1000.00 199.10 1000.00 199800.90
2 200.10 999.00 399.20 1999.00 199600.80
3 201.10 998.00 600.30 2997.00 199399.70
4 202.10 997.00 802.40 3994.00 199197.60
...
12 210.33 988.77 2456.01 11933.19 197543.99

So after 1 year, you will have made a total payment of $14,389.20. Out of that $2,456.01 is used to payback principal and $11,933.19 was used to pay interest. If you had taken out an interest only mortgage instead, you will not have paid back any principal. Assuming, you haven't invested the principal money that you didn't pay in an investment vehicle which earned you an income and the interest rates you'd get on the two loans are the same, the only difference would be the $2,456.10 principle payback you have on the traditional mortgage.

In the past, almost no one took out interest only loans on primary residences. These days, with the real estate market boom and the soaring housing prices, some people are electing to go with interest only loans. Some people are buying the most expensive house that they can afford with the interest only loan (interest only - lower monthly payment- afford to buy more expensive house) expecting the price to go up fast so that they can flip the house and make profits. This is obviously a very risky thing to do. I personally would not recommend anyone getting an interest only loan on the primary residence since fort most people it will be the source of biggest asset as well as the biggest debt.

[SoccerDude28]

Gillsie thanks a lot for the explanation.

Let me ask you this. Let's say for example you borrow 200,000 as mortgage, you take an interest only loan for 5 years, and you only pay the interest (but you save in the bank the rest of the money that you would have payed as the principal). How are you in risk after the end of the 5 years? Do you have to pay a much higher interest rate? If it is just a matter of paying the principal, well you are accumulating it in the bank, so you just take it from there and pay it. Where is the risk involved in Interest only loans if you are saving the principal.

[Lucien21]

Here in the UK you can get an Endowment mortgage.

In effect you pay interest only to the mortgage provider, but at the same time you also pay into an investment portfolio linked to stocks and shares which in theory at the end of the mortgage term should have enough to pay off the principle.

It was very popular in the 80's/90's, but recently there has been massive problems when endowment policies were predicting a large shortfall and alot of people were forced to take out other policies or loans to make up the difference.

That's what happens when you gamble on stocks and shares.

[lakerz]

I've done a lot of reading/talking to people about the whole property buying thing the past two years. Here's Gillie summed up interest only loans pretty well.

Pros:
Much lower mortgage payment so you can take any extra money and either pay into the principal or invest it or stuff your pillows with it.

Studies show the average US property buyer moves every 7 or so years. People are constantly buying a place, then selling and moving their money to a more costly and most likely larger place. In this scenario, interest only or adjusted rate mortgage makes some sense because with a fixed rate (as trepsie mentioned), the first 7 years the majority of your money is going towards interest anyway with very little cutting into the principal amount. A lot of people who buy a place with a fixed rate loan and then move after 5 years could have saved themselves quite a bit of money if they went with an ARM.

Cons:
While property is always a great investment since it repeatedly is proven to increase in value over extended time, any given 1-5 year stretch could show small to medium declines in value. So, any property you buy you may be stuck with for quite some time unless you're willing to take a loss or just walk away (your credit then goes to hell). Like I said, I've been looking to buy for 2 years, but it's a scary time to buy since property in California has just skyrocketed at a rate *way* over inflation and any other reasonable means of value.

With an interest only loan or ARM, you sign a contract saying the interest rate you pay will be good for X amount of years. After year X, that rate will be adjusted depending on how the prime is moving. Since rates are at rock bottom now, they can only increase so if you decide to keep your property after year X you will either have to go with the revised rate or re-finance the property. And again, if interest rates rise up very high when year X rolls around to the point that you could no longer afford the mortgage, and yet the property value has actually decreased due to inflation, bad economy, market adjustment, etc. you would potentially have to walk away from it.

So, going with a fixed rate gives people peace of mind. Even knowing they will most likely be looking to purchase a bigger house down the road and going with an ARM will save them thousands, it's still worth the security to go with a fixed rate. They know what the mortgage payment will be for the duration of the loan, and they can be confident they can pay if down the road property values have sunk and they are forced to stick it out with the property they bought for another 6 years. People say it won't happen, but I think it is a very real possibility. I won't buy a place that I know I wouldn't be happy with for as long as it takes for it's value to increase.

So are you a gambler? Then go for the interest only or ARM and (hopefully) watch your properties value continue to rise and laugh all the way to the bank with the money you had saved on interest and invested in a nice small-cap stock which then proceeded to quadruple in value over that 5 year period and enabled to park a new Porsche 911 S in your garage.

[Intrepid Homoludens]

Soccsie, I just found this today, check it out:

U.S. Housing: Time to Buy, Sell or Rent?
National Public Radio (audio news file)

Talk of the Nation, July 13, 2005 · In various cities, soaring home prices have some people scrambling to buy into the boom, and others renting in hopes of a bust. Who's got it right?

Guests:

Pam Woodall, economic editor of The Economist

Elizabeth Razzi, real estate journalist and author of The Fearless Home Buyer: Razzi's Rules for Staying in Control of the Deal

Marco Van Akkeren, economist for PMI Group

Hope it's useful to you.

[SoccerDude28]

Thanks a lot guys (and girl). This really helps tons. You are all the best