pros/cons of interest only loans

I’m moving to Chicago and will be using my Chicago home as my primary residence. I’m keeping my Seattle home to use as a rental. I plan to refinance my Seattle home in order to cash out my home equity to use as a down payment for my Chicago home. It’s been suggested that I use an interest only loan for my Seattle home when refinancing.

What are the pros and cons of an interest only loan? If not an interest only loan, is there another loan program that may be more suitable investment wise in my situation?

Holly,

The drawbacks to the interest only loan are that if you are going interest only on a fixed rate loan it typically will cost you between .5-1 point. Also, it will be interest only for a set period of time typically five or ten years. After that period of time is up your loan is going to re-amortize over the remaining number of years so your payment is going to go up at that point. If you are not planning on keeping the property for long term then the interest only is not bad option. It will definetly help you cash flow better at least for the interest only term. Hope this helps.

I disagree a bit here. Interest only loans do not cost any more than fixed loans. The broker sets the pricing through the lender.

Interest only is your better option if you are not going to keep the property more than 5 years… This will provide monthly cash flow to free up for other investments.

However, if you can afford to cover your rental on a fixed mortgage, you do not need the monthly cash flow and you are very conservative, then by all means stay conservative… and obtain the fixed rate. I rarely come into contact with an investor that wants to stay conservative on their properties as they are quite savy with their monies and in need of monthly cash flow for other investments…

that’s the difference…

Purely a choice to be made by you. Are you going to make the most of your money on your properties? or are you ok with where you are and in for the long haul?

Jason,

All of the lenders that I use have a pricing hit to the discount for an interest only loan. I have never seen a free interest only loan. As you well know the customer either pays that at closing or it gets rolled into the rate via YSP resulting in a higher rate.

Chris,

I would have to disagree as well. You are thinking of subprime lenders I believe. They will usually hit you .125-.5 on the rate for interest only. A conforming lender such as countrywide there is no hit. Actually, the i/o rates are usually lower than the 30 year fixed. I think that you 2 were just thinking of 2 seperate scenarios.

Shaun,

My company charges 1 discount point for a fixed rate term and .250 for an ARM to get interest only. That is interesting that countrywide does not charge for interest only. Thank you for the info.

I have no discount fees…

Discount fees are there in case the client would like to buy down the rate. It should not be used to obtain interest only, I’m sorry to hear that’s what your company is doing.

If you are charging points/fees, you should be using the origination fee or broker fee line…

At least that’s what RESPA taught me… not to deceive the customer.

Jason,

I resent that you are suggesting I am deceiving my customer by charging for interest only. I am reading a Wells Fargo rate sheet and I am pasting it below.

INTEREST ONLY ADJUSTERS
3/1, 5/1, 7/1 & 10/1 LIBOR & Treasury 0.250

Maybe you are not allowed to use national lenders so you are not familiar with larger banks, but interest only is not “free”.

Chris,

As you know, many lenders have an adjustment to rate when offered an interest only product. We call this a “hit” to rate or price. They also have an adjustment for loan size, doc type, LTV, escrows, and so on… This is how you price out a loan. We all know this. But to charge someone a “discount fee” for interest only is in my opinion not very professional. Do you charge a “discount fee” for loan size? or LTV? or second home? No you don’t. Why? because this is what makes up pricing. Interest only is just another option for you to determine pricing.

Because then you are probably charging an origination fee, a broker fee and a processor fee. The only reason you should be using the “discount fee” line is if someone is going to buy down the rate.

(discount points) – Money the borrower pays the lender at closing to “buy down” the mortgage rate — get a lower interest rate on the monthly payments. One discount point equals one percent of the mortgage amount.

Of course your’re going to find Wells Fargo and all others that make an adjustment. Some lenders do, some don’t. But to charge a “discount fee”. No. In my opinion. Not professional at all. It alludes the borrower into thinking that they are getting a discount or buying down the rate… when actually all you are doing is offering an adjustment to pricing.

I’ve been in this business for a very long time and I’m licensed in most nationwide states and very familiar with how to read rate sheets, matrixes and underwriting guidelines. I am a commercial loan officer, a construction loan officer as well as a residential loan officer. But titles are titles, nothing more. My experience speaks volumes. You can see on my website that I’m very informed as well as very informative to the public. I am honest in this business. There’s no need to charge a “discount fee” for any adjustments to pricing with me. I am straightforward, absent of any junk fees, no processing fees, no spread out fees, just one straight origination fee. I make things simple and not misleading. It makes the customer more comfortable in knowing what he/she is getting charged and why…Given that the purpose of the RESPA restriction is to protect borrowers from being over-charged and deceived.

You were probably taught how to sell at the beginning of your mortgage career. Which many loan officers like you are selling discount fees for obscure reasons. However, this is what essentially leads to predatory lending.

Not saying that you in particular are involved in any which way, shape or form of predatory lending or violating RESPA. It is just that I have seen this before and I was taught through basic banking principles. I only utilize the “discount fee” line in case the borrower wishes to buy down the rate.

How did you violate RESPA?

Here’s a clip taken directly from RESPA:

[[Page 49135]]

(5) RESPA should be vigorously enforced to protect borrowers and
ensure that honest industry providers have a level, competitive playing
field.
In accordance with these principles, this proposed rule would first
fundamentally change the way in which mortgage broker compensation is
reported by requiring, in all loans originated by mortgage brokers,
that any payments from a lender based on a borrower’s transaction,
other than the payment for the par value \7\ of the loan, including
payments based upon an above par interest rate on the loan (payments
commonly denominated yield spread premiums''), be reported on the Good Faith Estimate (and the HUD-1/1A Settlement Statement) as a lender payment to the borrower. Additionally, in brokered loans, any borrower payments to reduce the interest rate (discount points’') must

[[Page 49136]]

equal the discount in the price of the loan paid by the lender, and be
reported on the GFE (and HUD-1/1A) as borrower payments to the lender.
These changes would require mortgage brokers to disclose, at the
outset, the maximum amount of compensation they could receive from a
transaction, and include the amount in the ``origination fees’’ block
of the GFE and separately on the GFE Attachment A-1. They would then
disclose the amount of the lender payment to the borrower that would be
received at the interest rate quoted, if any. Mortgage brokers would be
unable to increase their compensation without the borrower’s knowledge,
either by placing the borrower in an above par loan, and receiving a
payment from the lender (yield spread premiums), or by retaining any
part of any borrower payment intended to reduce the loan rate (discount
points).

In other words, you are charging a discount fee to get below “PAR” and you’re paying the lender a “discount fee” instead of the lender paying you a rebate or yield spread. And therefore, by you charging someone a “Discount Fee” for something other than buying the rate down below “PAR” and still receiving a rebate, you have violated RESPA.

Jason,

I understand everything you are saying. I appreciate your detailed answer. I guess where the misunderstanding came into play was when I used the word “discount” instead of fee. When I am working through a loan for a customer and they want some product that has an “adjustment” I offer them the choice of either paying it at closing as a “fee” such as escrow waiver, interest only, etc… or they have the option of taking a higher rate and using the YSP to cover the cost. I apologize for the misunderstanding. All I was try to allude to is that there is a cost involved in going with an interest only loan. My company as well as most others do not allow us to charge discount points that are not related to buying down the rate even if they are subtracted from the YSP. Therefore I have never violated RESPA at least where it comes to discount points. LOL. I wish I did not have to charge a processing fee.

Funny how you modified your previous threads to remove the “discount fee” argument. I must be seeing things.

I was correcting an error. Funny how you like to pick arguments. I have seen you pick arguments with other loan officers on this site and have always given your character the benefit of the doubt. Guess I was wrong about you and Ben was right. Sorry.

Maybe you should take the money from you discount fees and go buy yourself a RESPA class.

I guess this thread doesn’t make that much sense once it got modified.

I think the whole point is that an interest only loan is going to cost more than a conventional 30 year loan in terms of the interest rate. Reading a rate sheet, it appears that at the same YSP, there’s about a 3/8-5/8 difference in rate. This could mean that if the 30 year rate was 6.75, the interest only rate would be 7.125, so the interest rate is higher, but overall your monthly payments are lower. That all makes sense right?

Lendinghand, are you trying to imply the above isn’t correct or was it all lost when the original message was edited?

long story short. Christopher was saying that the difference was that “interest only” cost more. Then he added that his company charges a discount fee for “interest only” on the discount fee line of the GFE. I debated that this was a violation of RESPA… as you can see… then he went back , modified his thread… retracted… and stated that he was misunderstood.

Hollyberries,

I’m sorry your post was turned into an argument. But in MY experience an interest only loan will have a very minimal cost associated, at the VERY most .25% interest rate. If you want to obtain the lowest payment, this is the way to go. Almost all I/O loans are 10 years interest only, which is plenty long enough as most people refinance every 4-6 years anyway.

Bottom line, DO THE INTEREST ONLY LOAN. There is no reason Not to do it.