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Will I build equity faster by going with an Interest Only program?
Stephen,
My wife and I are planning on buying a new home and are trying to decide on financing options. The house is $250,000 and we want to borrow $200,000 and were originally interested in a 5/1 ARM. I spoke to one loan officer who suggested that I would build equity faster by going with an "Interest Only" program and use the savings to prepay the principal. Is this true?
- Marc J. in Fairfax, VA
Marc, this is a question I get all the time, let's break it down and say that the rate on the 5/1 ARM you are considering is 4.500%. The principal and interest payment is figured on a 30-year amortization and equals $1,013. Interest Only loans are always at a higher rate usually between .125% and .375% higher. So if we figure Interest Only at 4.75% we come up with a payment of $792, a difference of $221. If you prepay $221 for the first 60 months, you will have paid down the loan $14,934, but the amortizing loan will be reduced $17,684 over the same time period. That's a difference of $2,750!
The explanation is simple – lower rate means cheaper money.
Is Interest Only ever the right choice? Yes, when there is a better opportunity for the money you save than paying down your mortgage such as paying down high interest debt, setting up a college fund, or retirement planning.
If you have a question that you would like me to answer please email me at Stephen@katzmortgageteam.com.
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