The Math of Adjustable Rate Mortgages

By
Mortgage and Lending with Jacob Dean Mortgage

The Fundamental Question: Does An Interest Only Mortgage Save Me Money?

So here is an example of the math of a hypothetical 30 year mortgage compared to the same mortgage with an interest only option for the first 5 years.

$350,000 for 30 years fixed at 7.0%

The traditional payment, principal and interest, would be 359 payments of $2328.56 and 1 final payment of $2326.94 for a total of $838,279.98

That same mortgage making interest only payments for the first five years would give you 60 payments of $2041.61, then 299 payments of $2474.73 and 1 final payment of $2471.50 for a total of $864,616.97 for a difference of $26,336.99 .

While your payment during the first 5 years saves you roughly $287 per month, you will then pay almost $147 more per month for the next 299 months in order to pay the mortgage off by the end of the 30 year term.

Is this a good deal? Well, it can be under certain situations and there are some assumptions built in as well. First of all, most home buyers do not stay in the same home (not to mention the same loan) for the full 30 years. The balance of monthly savings will come at the expense of a higher payoff when you sell. Plan on refinancing? Again, since you have no idea what the prevailing rates will be, you cannot predict the benefit of financing a higher loan balance (since you have not paid down the principal) with a lower interest rate, EVEN IF IT IS AVAILABLE. Quick math, interest only for 5 years at 7% then refinance down to 6.5% for another 30 years would actually cost you $80,625 MORE than the original fully amortized 30 year mortgage. This does not included ANY points of fees of the refinance and it is typical to pay just a touch more (higher interest rate) for a mortgage with an interest only option.

A lot of math, I know. PLEASE PLEASE PLEASE consider how much saving a couple hundred dollars can cost you, and make an extra payment here and there to cut as much long-term interest as possible.

 

About the Author: Brian Piper is a Senior Loan Officer with East West Mortgage in Vienna Virginia, one of the largest brokers in the country. Also on the web at www.VirginiaLoanPro.com

Comments (6)

Bruce Bourgault, Vice President, Mpro
Central Pacific Homeloans - Honolulu, HI
Hi Brian -- I don't dispute your math at all, but if you take out a I/O and Prepay principal every month the savings can be significant.  Aloha
Aug 27, 2007 07:56 AM
Brian Quigley - 720-524-3215
The Mortgage Network NMLS#244003 - Denver, CO
COBROKER1 - NMLS#244003 The Mortgage Network

In my personal opinion, the only benefit ((( I do have an interest only loan by the way on my mortgage)) of an interest only loan is to take that savings and put it towards an interest bearing account religiously every month.

 

Example, if you save $200 a month, and get 8% on your money guaranteed through a no loan mutual fund, over the course of five years, your mortgage will not go down, however you will have accrued compound investment interest with your mutual fund, which should far outweigh the paid down balance of the mortgage over five years

 

Aug 27, 2007 10:57 AM
Peter M . Christopher
Fairfield County Home Inspection LLC - Fairfield, CT
Residential & Commercial Inspections in
Welcome to A/R You will find this is a great place to network,
Aug 27, 2007 01:51 PM
John Novak
Keller Williams Realty The Marketplace - Las Vegas, NV
Henderson, Las Vegas and Summerlin Real Estate
Welcome to ActiveRain, Brian! Great example of how what looks like a great short-term strategy can have poor long-term results. This is exactly what buyers need in today's market -- different scenarios so they can see the long term effects, rather than just shopping for the most convenient payment today.
Aug 27, 2007 03:10 PM
Brian Piper
Jacob Dean Mortgage - Vienna, VA
BestVirginiaHomeLoans.com
You know, I always tell my kids math (and science) is not only cool, but USEFUL. It just needs a little translation sometimes, which is what a professional loan officer is supposed to do.
Aug 28, 2007 03:25 AM
Brian Piper
Jacob Dean Mortgage - Vienna, VA
BestVirginiaHomeLoans.com

Believe it or not, but there are actually GOOD uses for interest only loans, and thier more exotic cousins. Below is a link to a business week article which discusses the "optimal mortgage product" in an optimal market.

 

http://www.brokeroutpost.com/loans/extclickverify.asp?url=http://www.businessweek.com/bwdaily/dnflash/content/sep2007/db20070921_855992.htm?chan=search

 

 

Sep 28, 2007 08:10 AM