Do I Have This Right? IO Loan

[Tommy_Dolitte]

For interest only loans....


1) Leverage up to the point you can afford (making sure you can save @ YOUR pre-determined FI rate in a worst-case scenario)----> aka LBYM

2) Location, location, location

3) Leverage the "savings" in mortgage payments...



http://www.military.com/Finance/Content?file=McKnight_070805.htm&area=Content


Is this it?  I didn't get the last paragraph---can someone explain?   

TD

 

[Craig]

Great question ... and we've decided to refi into a 30 year, fixed rate, interest only loan, through Quicken Loans.  Same rate as we're paying on our normal amortization 30 year, fixed rate loan now ... 5.625%.  Most interest-only loans are ARM's ... we passed on that idea.

Cost to refi isn't bad, and when complete, we'll make the same aggressive payments we do now ... amortizing about 4 times the required principal amortization in our current loan.

That's what he is referring to in his last paragraph.  When times are good, you can amortize principal to your heart's content ... and in our case, it is rather like investing in a 5.625% bond. 

Some folks (including me, previously) do indeed think these are dangerous loans.  But ... if you like to amortize and wipe out your debt, while hedging for future challenges, then these loans are really pretty interesting and handy.

In our case, every $10K in principal amortization translates into nearly a $50/month decrease in the required interest payment.  During the first 10 years, if we hit a rough patch of business / work, then we can back off on the payments, significantly ... AND, the required monthly interest payment has decreased in every month when we chose to amortize principal.  After the first 10 years, the loan switches to a fully amortizing 20 year loan ... based upon that same, fixed rate we negotiated today.

You've got the idea.  Trick is to avoid temptation, and NOT max the home purchase price based upon just barely making interest-only payments today.  Rather like a hammer ... you can use it to build, or you can use it to destroy ...

 

[Tommy_Dolitte]

Thanks. How you are you calculating the 5.625%?

I think seeing the math would help.

 

[Nords]

Great question ... and we've decided to refi into a 30 year, fixed rate, interest only loan, through Quicken Loans.  Same rate as we're paying on our normal amortization 30 year, fixed rate loan now ... 5.625%.  Most interest-only loans are ARM's ... we passed on that idea.

Geez, if we had a fixed-rate IO loan we'd have no incentive to pay it off.  I'd leave the entire amount to compound in the stock market.

If the next 30 years of inflation looks like the last 30, then each borrowed dollar would be worth 28 cents. Even at a relatively tame 3% it'd still be worth only 40 cents.

When does the principle on a 30-year IO loan have to be paid off?  One day before the 30 years is up?

 

[mickj]

Usually around year ten it converts to a regular amortization with whatever principal is left, and the payments jump up.

 

[Craig]

mickj, you're right ... 10 years interest only required, then it switches to a 20 year normally amortizing loan ... at the rate of interest locked in at the initial fixed rate, 10 years prior.

The interest calc is $10,000 * .05625/12 = $46.88 [techically, $10,000 * .05625 / 360 * 31 (number of days in the month) ... $48.44 in this example]. The 5.625% interest rate is negotiated at the time you lock in or close, and of course depends upon the market rates at that time.

We're hedgers ... paying down the home loan aggressively, while still DCA'ing into the market. Not willing to put all eggs in the home, or in the market. Personal choice.

I think I missed the boat originally on these I/O loans ... now believe them to be smart strategy for those who have the discipline to LBYM, amortize the debt, but still want to hedge for lean times.