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Interest Only Loans

What is a Interest-Only Loan?

An Interest-Only loan is a loan in which, for a set period of time, the borrower pays only interest on the principal balance, with the principal balance remaining unchanged. A loan may be interest-only for its full term or for just a portion of the term. If interest-only payments are for less than the full term, that portion is referred to as the “interest-only period” and typically occurs at the beginning of the loan term. Once the interest-only period has expired, the loan will begin amortizing and loan payments will increase in order to reduce the principal balance.

For example, a $100,000 loan with a 5.0% interest rate and 10 years of interest-only payments before amortizing on a 20-year schedule would have monthly payments $416.67 for the first 120 months (calculated as $100,000 balance times 5.0% rate divided by 12 months per year). Beginning in month 121, monthly payments would increase to $584.59 to account for amortization. Interest-only payments have the effect of increasing cash-on-cash yields as less cash is dedicated to debt service payments.

However, since the principal balance is not being reduced during the interest-only period, an investor is not benefiting from equity build-up during that time. Additionally, both the investor and lender may be incurring greater risk with an interest-only loan, as the principal balance at maturity will be greater than if the loan were amortizing throughout its term. For this reason, interest-only loans are typically only made in situations where a lender feels comfortable with the loan’s balance at maturity relative to the projected property value at that time or in situations where a property’s cash flow is projected to increase over time and may not be able to meet amortizing debt payments early on.

With a rental interest-only loan, you only pay off the interest each month and initial term, resulting in a lower monthly payment. After the initial interest-only period is over, you will be required to pay the principal and interest for the remainder of the loan term.

Today’s interest-only loans do not have balloon payments; they typically aren’t even allowed under The Dodd Frank Act for Qualified Mortgages (Fannie Mae and Freddie Mac). Although the Non-Qualified Mortgages do allow for interest only

DSCR loans (Non-QM) offers an interest-only term lasts for 10 years followed by a 20-year amortization period. Loans can be structured as a 30-year fixed or as adjustable-rate mortgages (ARM). If you were to choose a 10/1 I/O ARM, your interest-only period would last for ten years but after the ten years, your interest rate will adjust once a year until you finish repaying the loan.

The Parham Team believes in educating and engaging our customers throughout the loan process. We look forward to hearing from you to begin that process. Contact us today at 855-326-6802 or schedule a call with a Loan Specialist.