30 Year Fixed with Interest Only Mortgage

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This is one of my favorite interest only mortgages for the right borrower.  Currently I’m working with a single Mom who is self employed.  Her income is usually pretty steady but it can fluctuate at times.   She’s buying her next home and has enough funds from the proceeds of the closing of her existing residence to cover her closing costs and put 20% down.    She believes she will live in the new house forever.

Fannie Mae has added a nice feature to the old "meat and potatoes" stand-by, the 30 year fixed rate.   Now, it’s available with the first 10 or first 15 years with interest only payments and the rate is fixed for the 30 year term.     Here’s how current rates compare, based on the scenario I stated above:

30 Year Fixed Rate (No interest only option):  Note Rate 5.875% (APR 5.967%).  Principal and interest payment on a $300,000 loan = $1774.61.   At 10 years, the mortgage balance (with no additional principle paid) is $250,214 and at 15 years, the balance is $211,911.

30 Year Fixed Rate/10 Year Interest Only:  Note Rate 6.00% (APR 6.093).   Interest only payment on a $300,000 loan = $1500.00.    Assuming no payments are made towards principal for 10 years, the p&i payment at 120 months (amortized for 20 years at 6.00%) will be $2149.29.

30 Year Fixed Rate/15 Year Interest Only:  Note Rate 6.125% (APR 6.205).  Interest only payments on a $300,000 loan = $1531.25.   Assuming no payments are made towards the principal for 15 years, the p&i payment at 180 months (amortized for the remaining 15 years at 6.125%) will be $2,551.88.

There is a difference of $274.61 between the 10 year interest only and the fully amortized 30 year fixed rate.   If someone was planning on paying off their mortgage, they have the freedom to pay $275 a month towards principal and then they effectively have a 30 year fixed mortgage.    Or, they could also invest the $275 a month (a conservative interest bearing account at 5% would accumulate to approximately $44,300 in 10 years).

Another benefit about the 30 year fixed interest only mortgage is that you do not diminish your mortgage interest income tax deduction since your mortgage balance does not change.   Yes, you will have a higher balance when the interest only period is over and a higher payment when the mortgage is re-amortized, assuming the mortgage is not refinanced.   If the mortgage is not refinanced, it is most likely because the rate that was obtained 10 -15 years ago is more favorable than rates at the adjustment time.   

Most people will not retain their mortgage for 30 years.   Truth be told, they will either refinance or sell their home.   Flexible payments (no negative amortization) with the security of knowing  you have a fixed rate for a long long time…ahhh…piece of mind! 

I will continue to spotlight various mortgage programs on this blog.   Borrowers should always consult with their Certified Mortgage Planning Specialist before selecting their mortgage strategy…my little disclaimer.

Update  7/23/2007:   Conforming interest only fixed period mortgages are now qualified at the fully amortized PITI payment.

Comments

  1. I am so glad I found your blog! I had no idea lenders were offering 30 year fixed with 10 year (or 15 year) interest only period. Thanks for the info!

  2. Clifford, I’m glad you found this information and my blog helpful! If your loan amount is conforming ($417,000 or less) you will need to qualify with the fully amortized (regualar 30 year fixed) payment including taxes and insurance.

  3. I am currently looking at going this route. in what situations would you advise people NOT to go this route? what are the cons? (other than those mentioned)

  4. Hi Joshua, you should meet with a qualifed mortgage planner who can review your financial goals along with what ever mortgages you’re considering. With the 30 year fixed 10 year interest only, you’re not paying down your principal. Factors to consider are how long you plan on retaining your property, what your loan to value is and other factors. Qualifying for i/o loans is getting tougher, too.

  5. Does the mortgage payment go down durring the interest only period if the borrower pays off some of the principal?

  6. Great question, Bob. The payment will not change until the fixed period is over. So if it’s a 10 year fixed, the new payment will be calculated based on the balance at that time (extra payments towards principal will reduce the payments at the 10 year mark).

    So to answer your question, with the 10 year interest only 30 year fixed mortgage, your interest payment will not change during the first 10 years.

  7. Rhonda are you sure that the interest only payment won’t change if the principle is reduced during the initial 10 year fixed period? I was under the impression that the interest only payment was based off the principle so if principle was to go down the payment would follow suit. For a traditional fully amortized loan I know the payment won’t change and only the term will.

  8. Chris, I STAND CORRECTED. I had to double check guidelines and I was treating the 30 year more like an interest only ARM.

    PAYMENTS MADE TO PRINCIPAL during the interest only phase will decrease for thee remainder of the interset only period.

    (sorry for all the caps–I want to make sure that readers can see my correction).

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