Secrets Behind Interest Only Loans: Lower Payments, But Are They Right for You?Written by Tony Baricevic
Interest Only loans gained widespread popularity in 2003 when FannieMae, largest purchaser of secondary market home loans, provided guidelines to wholesalers for purchasing them. FannieMae calls it Interest First also known as Interest Only option. Until recently, this type of loan was common among seasoned investors who were looking for improved cash-flow allowing them higher profit margins and freeing up reinvestment capital. Interest Only options have also been available on 'negative amortization'* loans also known as Fixed-pay, Option ARM or Cash-flow ARMs among other names. However many Interest Only option loans like FannieMae Interest First do not have negative amortization. How Interest Only Loans Work: The loan can have an adjustable or fixed rate with an option to make interest only payment for a predetermined period of time, say five years. Usually after that time, loan payments become fully amortized and are recalculated to pay off loan in remaining 25 years. This can result in a significant increase in monthly payment if no principal has been paid down over Interest Only option period, unless you refinance. The benefits of this loan are definitely cash-flow and it is also easier to qualify, since payments are significantly lower. It can also be a good choice for people who are planning to sell their home in a few years, as they will have had a significantly lower payment while possibly taking a tax deduction of mortgage interest. One risk involved would be if value of property decreased when it came time to sell and they didn't have enough funds to pay off loan. Some common Interest Only option loans are; Fixed 15/15 Interest First which has an Interest Only option for first 15 years, or a Fixed 10/20 which has a 10-year Interest Only option and then gets amortized over remaining 20 years. There are also adjustable loans like a 5/1 ARM with a 5-year Interest Only option or a 3/1 ARM with a 10-year Interest Only option and still many more variations. Example: Here is an example of a 30-year Fixed Jumbo Loan with a 10/20 Interest Only Option: A $500,000 loan at 6% APR has a fully amortized monthly payment of $2998 which pays off loan in 30 years. The Interest Only payment of $2500 is $498 lower per month. If you only paid $2500 each month for 10 years without paying down any principal, fully amortized payment would adjust to $3582 in order to pay off loan in remaining 20 years.
| | How to tell if a property is overvaluedWritten by Mike McVey
In wake of incredible house price boom witnessed in most of developed world over past decade, a lot of ideas have sprung up as to how to value a house 'fairly'. The reason for this is that traditional methods, such as working out house prices as a multiple of salaries, or perhaps mortgage affordability as a percentage of income, seem to have 'stopped working' recently.There can be no doubt that house prices are .. ahem! .. at top end of their range compared to traditional valuation methods, but don't let anyone fool you that this is now 'norm', or that a 'new paradigm' is in place. Such talk rightly marks climax of an asset bubble, as witness dotcom bust as millenium rolled over. Many things can change as technology and societies develop, but basic human nature isn't one of them, and twin drivers of any asset bubble, fear and greed, are rather depressingly evident in this bubble too. So if you live in an area where houses are trading at, for example, twice historical sustainable relationship to salary, how can you tell whether this is 'ok' or 'bad'? Easy. There is one relationship that has stood test of time and wheathered all previous house price booms and busts - relationship betwen house as an asset, and return on that asset. What do we mean by this? Any asset has a 'return' - what you make for holding asset. Houses traditonally 'return' in 2 ways - by capital appreciation (house price growth) and by rent (if you own a house, you could rent it out). As it can be difficult to create a simple equation that factors in both these elements indivdually, they are usually rolled together, to give an easy way of comparing required sale price of a house against it's 'true' worth.
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