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An interest-only loan gives you the option of paying just the interest, or paying interest and as much principal as you want in any given month. The interest-only option is available for a fixed number of years, and always in the initial years of the loan. Interest-only loans can be traditional fixed-rate mortgages or adjustable rates. Quicken Loans offers interest-only refinance options that are interest-only for the first 10 years.
How Interest-Only Loans Work:
If you choose to make the interest-only payment one month, that month's payment is lower than it would be had you made the principal and interest payment. Your interest rate may or may not be lower than a traditional mortgage, but you will have the option of choosing your payment. Sophisticated homeowners know that having this type of payment flexibility is one of the smartest ways to manage your personal finances.
Refinancing from a traditional home loan into an interest-only loan has become popular because it gives you control over your cash flow. This example illustrates the payment flexibility of refinancing a $200,000 mortgage to an interest-only loan.
$200K @ 5.75% Interest-Only Payment.............$958.00
$200K @ 5.75% Principal and Interest Payment....$1,167.00
Cash flow difference is $209.00 a month.
It's this simple: with an interest-only loan, in months when you need more cash, you don't have to pay both principal and interest. You only have to pay the interest. This could significantly reduce your mortgage payment and leave you with more money to funnel elsewhere.
Who Is an Interest-Only Refinance For?
Refinancing to an interest-only loan is a good choice for anyone looking to make their money work harder for them. For instance, making interest-only payments and putting the difference into an investment which brings a higher rate of return. Traditional mortgages offer no such option. That's something to think about if you're not maximizing your yearly 401(k) and IRA contributions.
But there are other things you can do with the extra cash you can have every month:
- Pay down high-interest credit card debt
- Save for your children's college tuition
- Buy or lease a second family vehicle
- Increase your home's value by making home improvements
- Set aside money for a rainy day
Depending on your existing loan balance, refinancing to an interest-only loan could get you access to thousands of dollars over the course of several years to put to use as you think best.
An interest-only refinance may also be a good option for people who expect to be in their homes for less than the interest-only period.
The Truth about Interest-Only Refinancing
A big misconception about interest-only refinancing is that if you're not paying down your loan's principal every month, you're not building home equity. That's not necessarily true. Homes in the U.S. have been appreciating between five and six percent a year. Chances are that even if you're not paying down principal, appreciation is building equity in your home for you.
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