Fixed Rate Interest Only Mortgage
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Ever wonder if a fixed rate interest only mortgage is an appropriate choice? Or try to figure out why a bank would allow a customer to select the option of a fixed interest only mortgage? After all, the financial institutions are in the business of making money, not necessarily giving the homeowner a break. Will such choices really save the client money in the end? All these questions deserve an answer, and it would be good to begin with an understanding of what a fixed rate mortgage is in the first place. A fixed rate mortgage is just that -- one whose requirements remain the same during the agreed-upon period. The monthly payment includes enough money to pay the monthly expense on the loan and to repay the loan over the term. At first, much of the monthly payment will go towards interest, but gradually the balance will shift and the payment will begin to amortize the loan. Common lengths of time for this process are 15 and 30 year mortgages.
A fixed rate interest only mortgage is significantly different. In this process, for an agreed-upon length of time (commonly 10 years), the borrower is required to pay the monthly interest expense. Additional payment is allowed, but not required. By the time the preliminary part of the agreement has ended, generally most customers' loan balances have hardly been reduced at all. Then, the borrower has to repay the balance of the loan over the remaining years of the mortgage. Needless to say, the monthly payment will become significantly higher because one is trying to squeeze thirty years worth of payments into twenty years.
To make things even more complicated, most interest only mortgages are not fixed, but have an adjustable rate. These adjustable rate mortgages (ARMs) may begin as a fixed interest only mortgage. However, (again, commonly after ten years) the customer may have a yearly change in rate depending upon what is happening in the market. This causes the borrower to run the risk of being subject to greatly increased (and increasing) rates after this portion of the agreement has passed. A person may find great difficulty in adjusting his or her lifestyle to accommodate these higher payments.
Some may be willing to take a chance on an adjustable rate mortgage or a fixed rate interest only mortgage. Perhaps their wages are paid on an irregular schedule. In this case, the lower payment required on an adjustable or interest only mortgage may seem attractive. When their money comes in, they can then choose to make up for months when available cash simply allowed for the minimal required payment. This takes discipline, though. The temptation is always present to spend the money on some other area.
Another temptation with a fixed interest only mortgage is to buy more house than one can really afford. The lower payments required by this type of account may qualify a person for a larger loan. Some people look at this as a savings in the long run. They figure that it is less costly to buy the house they want (and may eventually need) than buy a 'starter house' and move up later. However, this presumes that the additional income which will be needed when the introductory portion of the agreement is ended will be available. What if one doesn't get that better job or promotion?
Others acquire a fixed rate interest only mortgage and plan to invest the cash they would normally pay on a regular loan. They believe that they will make more of a profit this way than in gains by increased equity on their house. This scenario has not one, but several uncertainties. A person needs to have the necessary discipline to not just intend to, but actually invest the money. That is difficult enough. Although one may insist that he or she will do so, the other uncertainty is that, regardless of disciplined efforts, it is impossible to guarantee that investment returns will keep ahead of the loan's requirements. This brings to mind what James 5:14-15 says: Whereas ye know not what shall be on the morrow. For what is your life? It is even a vapour that appeareth for a little time and then vanisheth away. For that ye ought to say, If the Lord will, we shall live, and do this or that.
A further consideration is that there is a certain level of deception going on regarding the advertised savings resulting from a fixed interest only mortgage. Even if the rate is stable for the life of the loan, to pay an interest only mortgage is always more expensive. This is because at the end of the introductory period, the balance is always more than the balance on a regular fixed rate account. Therefore, it is going to be more risky for the lender to provide such a loan. A person can be fairly sure that the financial institution is going to cover that risk by ensuring that they get additional monies somehow. Perhaps this will be reflected in a higher overall cost for the loan. Read the contract carefully before signing, even for a fixed interest only mortgage loan. Nearly always, even with a fixed rate, the cost will be higher on a loan with an interest only provision. Although sometimes a person can use this provision for their own advantage, it is prudent to be able to make a decision based on empirical facts rather than supposed benefits.
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