With an interest-only loan, you can simply pay the interest. Or you can pay the interest, plus as much of the principal that you decide to pay in any given month. Interest-only loans, which are available for a fixed number of years - and always in the loan's initial years - may be fixed-rate mortgages or adjustable rate mortgages (ARMs).
This is how they work: in the month that you opt for interest-only, your payment is lower than a principal plus interest payment would have been. This payment flexibility gives you a great deal of control over your personal finances. Many people, recognizing the control of their personal cash flow afforded by an interest-only loan, have decided to refinance from traditional home loans to interest-only loans. For an example of the payment flexibility in such a refinance, let's take a look at how refinancing a $200,000 traditional mortgage to an interest-only mortgage might work:
$200K @ 5.75% Interest-Only Payment.............$958.00
$200K @ 5.75% Principal and Interest Payment....$1,167.00
Cash flow difference is $209.00 a month.
The Advantages of Interest-Only Refinance
Say there are months when you need more cash? If you've got an interest-only loan, you don't have to pay both principal and interest. You only have to pay interest. Interest-only refinancing is also a good option to consider if you expect to be in your home for less than the interest-only period.
The reduction in mortgage payment with an interest-only refinance gives you the greater spending power of additional money to use however you need it. If you contributed that extra money to your 401(k), for example, you would be managing your finances in a way that allowed you to let your money work harder for you. A traditional mortgage would not give you that option. In fact, refinancing to an interest-only loan could, over the course of several years, give you access to thousands of dollars - depending on your loan balance. These are just a few other ways you could make your additional money work for you:
&bull Pay down high-interest credit card debt
&bull Save for your children's college tuition
&bull Buy or lease a second family vehicle
&bull Increase your home's value by making home improvements
It's also important to realize that, in a period when homes are appreciating in value, that appreciation is building equity in your home. So even if you're not paying down your loan's principal, you can be building home equity at the same time that you gain the cash flow advantages of interest-only refinance.
