The Power of Interest Only Financing
A New Financing Tool
•Interest Only financing has been available for decades but was only available to the very wealthy financing multi million dollar properties
•Only a very few creative lenders began offering it as an option on ARMs in 2003
•It is now an option on both ARMs and fixed rate products
The Problem with Traditional Financing
•Traditional mortgage financing relies on an amortization schedule that loads most of the interest cost into the early years of a loan
•When refinancing or purchasing a larger home, clients are often shocked to find out how little their mortgage balance has been reduced in the first 5 years.
If you plan to stay in a home for many years, some will recommend making additional payments to “build equity faster”.
However, there are two problems with this approach. It is impossible to recover your money without selling or refinancing. The extra money is subtracted from the end of the loan and you do not see the benefit for 20-30 years.
•Consider this…
•On a $250,000 loan using a 30 year fixed rate of 6%, you are paying $248.88 in principal and $1250 in interest for a total of $1498.88
•At the end of 5 years you have paid $17,365 toward the principal, $75,000 in interest and your loan balance is $232,635
•If you chose a 15 year fixed at the same interest rate it is only marginally better. Your payment is $2109 which is made up of 859.64 in principal and the same $1250 in interest.
•In 5 years your loan balance is $190,022, equity of $59,978 and you paid the same $75,000 in interest. Better, but most cannot afford the additional $610.76 payment.
•If you choose a 40 year term, to lower the payment the situation is much worse. Your payment drops to $1375.53, you paid the same $1250 in interest but your principal payment is only $125.53.
•In 5 years your balance is $241,241. You paid the same $75,000 in interest but you only have $8,759 in equity. Pretty sad.
The Advantage of Interest Only Financing
•Staying with our $250,000 loan at 6% if we are paying interest only, our payment is only $1250 but we are not lowering our balance yet.
•What will you be able to do with the monthly savings of $248.88? Qualify for more house? Certainly.
•If you qualified for the $250,000 loan at 6%, maintaining the same debt to income ratio, converting to an interest only loan means that you now qualify for a $300,000 mortgage. Will an additional $50,000 in purchasing power get you a nicer home? You know the answer but there is something else to think about.
•If you have any consumer debt with an interest rate above your mortgage rate, good financial planning tells us to pay that off first. Take the $248 we save every month and apply it to your credit card balances until paid off. Your home is still increasing in value while you are becoming debt free. Next, we will see how to build wealth using your mortgage as a tool.
•Now that you are debt free, lets focus on building wealth with our mortgage as a tool. With an interest only mortgage, you are always required to make your interest payment, but you have the right to make any additional payment at any time you wish. Now is the time to make the additional $248 payment.
•But lets do something even better for ourselves and add in what we have saved by paying off our consumer debt. Assume your minimum payments were $200 and we add that to our $248 principal payment that we would have made with the traditional mortgage for a total payment of $1700. $1250 interest plus $450. Where will we be in 5 years?
•Remember, if we took out a traditional mortgage, our balance would have been $232,635.
•Using an interest only approach but making a contribution of $450 to principal gives us a balance in 5 years of $218,603. $14,000 more in equity! You are now using your mortgage to manage your finances.
•Lower payments
•Qualify for a larger mortgage
•Available in fixed rate or adjustable rates
•Pay off consumer debt with the savings
•Flexibility in repayment schedule
•Your results may be different than in our illustration. Give me a call to discuss your specific situation.
Monthly Recasting
•If you are willing to share some interest rate risk, you may consider either the Asset Manager or Cash Flow ARM. In addition to interest only payments, they recast monthly. Payments are calculated on the monthly balance. Make an additional payment and you have a lower payment the next month! Used correctly, this is an incredible tool to manage your finances.
Lone Star Funding Partners, LLC
281 852-7836
Humble, TX 77346