Tuesday, January 15, 2008

How to Compare Interest-Only Mortgages

Introduction

Interest-only mortgages are loans that do not apply payments to the principal for a specified amount of time. Comparing interest-only mortgages can be like opening a can of worms, but is a necessary step in determining the best loan for you and your situation. Why would you choose an interest-only mortgage? While the rates are usually within a percentage point or two of the going traditional fixed mortgage rate, an interest-only loan will allow for lower monthly payments during the beginning of the loan—usually for the first 15 years of a 30-year loan.

Instructions

Difficulty: Easy

Steps

1

Step One

Familiarize yourself with terms common to an interest-only mortgage:

- Mortgage amount is the original balance of your loan.
- Loan term is the number of years or months from the beginning to the end of the loan.
- Interest-only period is the period that no portion of the payments are applied to the principal.
- Interest rate is the percentage of the mortgage balance you pay to use the bank’s money.
- Your monthly payment is the amount due each month. Later in a loan term, it will include interest and principal.
- Total payments is the number of payments that will be required over the life of the loan.
- Final payment amount is the anticipated balance of principal upon maturity of the loan.
- Total interest is the total amount of money you’ll be paying in interest over the life of the loan.
- Prepayment refers to additional payments made during the life of the loan. Prepayments are applied directly to principal, reducing the interest over the life of the loan. You may make prepayments monthly, yearly or as a one-time payment.
- Savings is the amount you’ll save over the life of the loan by making prepayments.
2

Step Two

Visit lender Web sites to use their free interest-only mortgage calculator.
3

Step Three

Input the loan amount, loan term, interest-only period and interest rate you have been quoted.
4

Step Four

Enter any foreseeable prepayments you will make.
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Step Five

Click "Calculate" and then click "View Report."
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Step Six

Print the report or save it in an Excel spreadsheet:

- With the report on screen, hold down CTRL and press A.
- Then hold down CTRL and press C.
- Open an Excel spreadsheet by clicking "Start," then "Programs," then "Microsoft Excel."
- Hold down CTRL and press V.
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Step Seven

Repeat with other loan offers, printing or saving to a new Excel worksheet.
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Step Eight

Look at the following data points for comparison:

- Ending principal balance—will you have to make a large payment at the end of your loan? Do you intend to keep this loan until it has matured? Will this balloon payment cause a hardship?
- Interest savings for prepayment—will you be able to make prepayments?
- Total interest paid—this is the actual cost to you.

Tips & Warnings

  • Visit a number of mortgage rate providers to compare loan terms and rates. One size does not fit all.
  • Call mortgage brokers and ask for their quotes in writing.
  • Contact your bank or credit union for preferred customer rates. The more you have to compare, the better your final deal will be.

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