8

I am planning to refinance my primary residence. I am intrigued by an interest only mortgage like the ING Orange mortgage because of the low interest rate. But I know if all I ever pay is interest then at the end of the term I'll owe a bunch. But I am a very disciplined person. So my thoughts were to take out the interest only mortgage but pay enough extra each month to be paid off at the end of the term. Then I would be taking advantage of the lower interest rate which right now is about 2% lower. That is a significant interest savings over the life of the loan. Is this a bad idea? Am I missing something?

EDIT: I also need to confirm with ING that I am allowed to pay extra towards principal without any penalties. Yes you can pay extra principal without penalty.

EDIT2: Let me try and answer some of the questions being posed to me. I plan to stay in this house for the foreseeable future. Obviously one never knows about job, economy, etc. But I plan to stay for 10-15 years min. So my main goal is to pay the house off as soon as possible. This would be over and above our retirement savings. Still plan 15% of income for that. After reading some more on ING's site it seems this is not an interest only loan but not a typical arm either. It is a loan for 5 years with the principal and interest payments structured as if it is a 30 year loan. After 5 years I have the ability to refinance with ING for no closing costs at their current rate. So the main risks I see is if I don't get it paid off in 5 years (unlikely I will be able to that fast) I'll need to refinance with them or someone else at the current rate 5 years from now.

  • I also need to confirm with ING that I am allowed to pay extra towards principal without any penalties. Without knowing for sure, I'm going to guess that you already identified the sticking point there. – Michael McGowan Jul 7 '11 at 16:48
  • 1
    What affect does making payments towards principle have on your loan payment with such a loan? With a normal loan, the amount of interest you pay each month is less and less, and the amount of principle more.. but with this interest only loan, will the payment(interest only) stay the same even if you make a principle payment? – Chuck van der Linden Jul 7 '11 at 19:18
  • 1
    In terms of missing something. An 'interest only' loan places the bank at higher risk because their exposure (amount you owe) is never reduced, so normally I would not expect such a loan to have a lower rate than a fixed period loan. Are you SURE that the "Lower Rate" is not perhaps because you are looking at an ARM loan? Or perhaps you are confusing 'lower rate' with 'lower payment'. What is the actual rate and loan period you are looking at? BTW in order to provide good answers, it would be useful to know how long you expect to stay in the property before selling. – Chuck van der Linden Jul 7 '11 at 19:29
  • 1
    Are you sure something isn't wrong here? I checked ING Orange mortgages interest and the 5 year variable mortgage rate is 3.25%. You're not really getting 2% less than that, are you? – DJClayworth Jul 7 '11 at 19:50
  • 2
    EDIT2 makes a huge difference to this question, effectively making half the answers here irrelevant. The difference is now between a rate that is fixed only for five years and a longer fixed rate. – DJClayworth Jul 7 '11 at 19:57
7

Really the question you need to ask yourself is how much Risk you want to take in order to save a little on interest for 5 years.

Rates are pretty close to a historic low, and if you have good credit you should shop around a bit to get a good ideal of what a 15 or 30 year fixed loan would go for.

For people that are SURE they will be selling a property in a few years, a 5-yeah balloon, or ARM might not be a bad thing. OTOH, if their plans change, or if you plan to stay in the property for longer (e.g. 10-15 years) then they have the potential to turn into a HUGE trap, and could have the effect of forcing you to sell your house. The most likely people to fall into such a trap are those who are trying to buy more house than they can really afford and max out what they can pay using a lower rate and then later cannot afford the payments if anything happens that makes the rate go up. Over the last three years we've seen a large number of foreclosures and short-sales taking place are because of people who fell into just this kind of trap.. I strongly advise you learn from their mistakes and do NOT follow in their footsetps

You need to consider what could happen in 5 years time. Or if the economy takes off and/or the Fed is not careful with interest rates and money supply, we could see high inflation and high interest rates to go along with it. The odds of rates being any lower in 5 years time is probably pretty low. The odds of it being higher depends on who's crystal ball you look at. I think most people would say that rates are likely to increase (and the disagreement is over just how much and how soon).

If you are forced to refinance in 5 years time, and the rates are higher, will you be able to make the payments, or will you potentially be forced out of the house? Perhaps into something much smaller. What happens if the rates at that time are 9% and even an ARM is only 6%? Could you make the payments or would you be forced to sell? Potentially you could end up paying out more in interest than if you had just gotten a simple fixed loan.

Myself, I'd not take the risk. For much of the last 40 years people would have sold off their children or body parts to get rates like we have today on a standard fixed loan. I'd go for a standard fixed loan between 15 and 30 years duration. If you want to pay extra principle to get it paid off earlier in order to feel more secure or just get out from under the debt, then do so (personally, I wouldn't bother, not at today's rates)

  • Ha. I just upvoted this, mostly for the very accurate-sounding: "The odds of it being higher depends on who's crystal ball you look at. I think most people would say that rates are likely to increase (and the disagreement is over just how much and how soon)." Then I noticed the timestamp, and... well dang. It was posted just about exactly 5 years ago. So much for that prescience :D. 5 years later, rates totally went lower, and only now are we solidly expecting them to go back up, most likely. – neminem Aug 24 '16 at 21:25
  • har! yep at the time rates were lower than we had seen in a huge time, and there was a lot of thought that they could not go much lower.. I still think my answer was good advice, as I've known far too many people that overbought during the housing price bubble of the prior decade. (and it was a bubble, just find a 100 year chart and look at the trend line, we were way above it). I'm frankly a bit worried we are headed to a second bubble because so many folks "waiting for prices to go back where they were" don't realize the drop in 2008 basically took us back to the trend line. – Chuck van der Linden Aug 25 '16 at 6:16
  • really it comes down to do you want to refinance on your own terms (if rates drop enough to make it worth it) or be forced to refinance on someone else's schedule when rates might be a lot higher, or your house is perhaps underwater and you can't borrow enough against it to even manage a re-fi – Chuck van der Linden Aug 25 '16 at 6:21
4

Generally, interest-only mortgages are a bad idea, because a lot of people get them so that they can buy more house than they could otherwise afford (lower payment = affordable, in their minds). If the house continues to go up in value, they probably get away with it, because when the balance becomes due, they can refinance. However, the last few years has shown how risky that strategy can be, and this kind of things is what cost a lot of people their houses.

In your case, if the house is something you could afford on a regular 15 or 30-year mortgage, and you really are as disciplined as you say you are, you might get away with it. But you have to take into account the risk, and consider what happens if there is a job loss or similar difficulty in the future.

Another thing to consider is the term of the mortgage. How many years will you get this lower interest rate? Interest rates are at historic lows right now, and pretty much everyone thinks they're going up soon. You might be better off locking in a higher rate for 15 years.

3

If you took a fixed loan, but paid it off at the accelerated rate, you would ultimately pay less total dollars in interest.

So compare the actual amount paid in interest over the course of the loan rather than the interest rate itself. That should be your answer.

Also, plan on failing in your plan to pay it off and see how that will affect you.

2

Normally interest only mortgages are taken incase one planning to sell off the property after a few years and purchase of the property is for investment. In such a case instead of burdening oneself with a huge EMI, one opts for an interest only mortgage, and towards the end of the term, sell off the house at profit and repay back the entire principal.

I am not to sure if interest only mortgages are encouraged for properties you plan to live in. Although I do not know about the ING scheme, normally there is no prepayment option on interest only mortgages, its Bank way of earning a fixed income for the contracted period and thats the reason why the interest rates are lower than a regular mortgage. If you do the math, you may be paying more in total interest than on a regular mortgage.

2

It's an interesting question, and one that has a few tentacles. A few thoughts come to mind:

  • paying down the principal quickly seems counter-intuitive. I would have thought with this loan you'd be wanting to do the exact opposite (see next point).
  • how are your savings looking, and retirement? Rather than paying down the principal, can you put that cash into these accounts?
  • how are prices behaving in the area where you are purchasing? And a corollary of this: how long will you likely stay in the house? If the prices are still trending down, and you think you may sell in the mid term (say in 5 years), then it's not a good option.
  • how okay are you with the risk that refinancing (if necessary) could result in an unattractive outcome? (Per the ING site's list of risks.)
  • as you will be effectively renting from the bank, are you better off renting?
  • do the benefits outweigh the risks? I must say the ING site makes it sound like a lesser option.

There's nothing wrong per se with these arrangements. I think it's a matter of doing what feels comfortable. Hopefully someone on here will have a personal experience to share.

0

It seems you understand the risks, it seems like a fine enough idea. Hopefully it works out for you.

However, you may want to talk to a few local banks about getting a short term home equity loan. I know someone who was able to do this getting a very low rate for 7 years. At the time of the loan, the prevailing rate for a 15 year was 3.25, but they were able to get the HEL at 2.6 fixed. There was no closing costs.

The best part about it was the payment was not that much more. While going from ~1200 to ~1800 is a 50% increase it was not that much in dollars in relationship to his household income.

Note that I did not say Home Equity Line of Credit, which are vairable rates and amount borrowed.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.