Question from a reader: Are the 30 year fixed interest only fixed for the full 30 years?

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The answer is yes, the rate is fixed…BUT… The rate is fixed for 30 years however depending on if you select the 10 year or 15 year interest only period, once the interest only period is over, the mortgage will be amortized at the same rate for the remainder of the term.

For example, let’s assume your mortgage balance is $350,000 and the rate for the 30 year fixed with interest only payment is 6.50%.

The interest only payment is: $1895.83

If you have the 10 year interest only product (usually a slightly better rate), the payment will adjust to a fully amortized mortgage based on the remaining 20 year term.   The new payment would be:  $2609.51

If you opt for the 15 year interest only product, the fully amortized mortgage based on the remaining 15 year term  be:  $3048.88

Both of the above scenario’s are assuming that there are no additional payments made towards the principal during the interest only period.   NOTE:  borrowers may need to qualify at the fully amortized payment (not the interest only payment).

Here is the email from the reader:

"Currently, we have a subprime loan with a 2-year penalty which expires  March 2008. We were told that it is a 40 year fixed at 8.83% and if we refinanced prior to the 2-year penalty expiration date, there will be a 6-months of interest penalty. However, we recently reviewed our loan documents and with a better understanding called the lender. The lender confirmed that we have a subprime loan and the rate will be adjustable after the two years.

We are considering the 30-year fixed, 10 year interest only, but want to be sure that the rate is definitely fixed for the full 30 years. We are in our mid-40s and have no intentions of selling our home, and consider this home to be our retirement home. From your financial expertise, do you think this is a good option for us?"

It’s difficult to provide advice for someone when you don’t have their entire financial picture.   This couple does not live in Washington State (where I’m licensed to practice).   

Here are factors that I would consider if I were their Mortgage Professional:

  • How much funds do they have currently reserved for their retirement?  (With their current loan being subprime, I’m assuming they are underfunded.   Most Americans are).
  • What do they anticipate their retirement income to be in 20 years?
  • How is the appreciation/depreciation in their current region and with their home?
  • In 20 years, when they retire and their income is different, can they afford the 20 or 15 year amortized payment? 
  • Are they needing the interest only payment to make current ends meet?
  • What are their financial goals for retirement?  To have no mortgage?  To be debt free?   To hang onto their house with the mortgage as a tax favored debt? 

I would caution against doing "band aid" loans that will need refinancing when you’re at retirement or close to then.   Depending on what you anticipate your income to be, should you need to refinance out of a 15 or 20 year term mortgage because your income is less, you may not be able to qualify.   You may want to consider a traditional 30 year fixed or a Fannie Mae or Freddie Mac 40 year fixed rate (without the balloon or adjustment that you have with your current mortgage).

Here are the rates I quoted last Friday (just to give you an idea of how these rates may vary from product to product):

30 Year Fixed: 6.125% (APR 6.281%).  Payment per $1000 = $6.08.

30 Year Fixed with 10 Year Interest Only:  6.500% (APR 6.653%).  Payment per $1000 = $5.42.

40 Year Fixed:  6.500% (APR 6.646%).  Payment per $1000 = $5.85.

I give them huge kudo’s for reviewing their loan documents and contacting their lender and for getting second opinions.   Their Mortgage Professional should review all possible mortgage options with this couple and make sure they understand the terms and any consequences. 

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