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Interest-only vs. amortized payments

[Nov 11, 2010.]

 

The basics of interest-only vs. amortized payments

When you are choosing a second mortgage, you will likely be given the choice of either interest-only payments or amortized payments. Interest-only payments are less money each month, depending on your interest rate, because you are not paying down the principal balance. Amortized payments are more money because each month you are paying down principal. Know this, even interest-only loans have to be repaid at some point. Normally you get an interest-only period of between five or ten years, then, the amortized payments pay the principal balance off in the remaining twenty-five or twenty years, respectively. While interest-only payments may start out lower, in the end, that can be quite high.

Home equity loans

Home equity loans can be either interest-only or amortized. Typically, home equity lines of credit (HELOC) have interest-only payments for the first five or ten years. Fixed rate second mortgages usually have amortized payments right from the start. So, if you are interested in a second mortgage with interest-only payments, you may want to look into a HELOC. If your main goal is to repay the loan, a fixed rate second would be your loan product.

Pros and cons of interest-only payments

Pros


  • Monthly payments are cheaper because you don't pay down any of the principal balance.

  • There may be a tax advantage due to paying more in interest. Consult with a tax professional.


Cons

  • The lender may charge a higher interest rate for the option of interest-only payments.

  • The monthly payments can get very high towards the end of the term when amortization begins.


Pros and cons of amortized payments

Pros

  • Because you are paying down the principal from the first payment, you should pay less in interest for a loan with amortized payments.

  • The monthly payment will stay the same for the life of the loan.

  • Often, a loan with amortized payments has a fixed interest rate, though not always.

  • Amortized payments represent less risk to a lender, so the lender may offer a better interest rate for this type of loan.


Cons

  • Monthly payments are more expensive because you are paying down principal each month.

  • The amount you can deduct on your income taxes is reduced over time as the principal gets smaller and smaller.


Consider the above pros and cons with a mortgage professional. An experienced home loan professional can look into your specific case and help you determine the loan product that will benefit you most. Contact a home loan professional now.

 

About Author:

Renee Morgan has been a loan officer for over eighteen years. She is also a freelance writer and guest expert for radio and TV.

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