â€œWhat is the different between interest-only loan and fixed rate loan?â€
An interest only (IO) loan simply means that for the initial fixed period (3, 5, 7, or 10 years are still available) you simply pay interest. As an example, letâ€™s assume the following scenarioâ€
Purchase Price: $640K
20% Down: $128K
Loan: $512K @ 5.50%
Traditional Payment: ~ $2,907
IO Payment: ($28,160/12) or ~$2,347 ($560 per month less, or $6,720 annually)
â€œDoes it make sense to go for interest-only loan for first 6 years?â€
If you are going to be in the property for more than 10 years I would say to go with a standard 30-year loan as this will provide you with great options later (sell or convert property to rental).
If, however, your occupation timeline is 10 years or less considering, in my opinion, an IO loan is a smart move in the current financial and housing environment. But first, a question: What type of consumer are you? Are you able to subscribe to a strategy in order to reap a future benefit? If so, consider the IO loan if you can ASSURE monthly payment savings will be SAVED). Hereâ€™s why (using figures from above and assuming a 7-year loan/occupation period):
1) At the end of 7 years with the traditional loan your total paid-in principal would be $57,264 and paid interest would sit at $186,932 - a total outlay of $244,196.
2) At the end of 7 years with the IO loan your total paid-in principal would be $0 and paid interest would sit at $197,148 for a total outlay of $197,148. Additionally, you would have accrued SAVINGS of $47,040 (not including any accrued interest).
Now, a few facts to consider: Every dollar paid in principal has an investment return of 0%. You might gain a dollar of equity by paying in principal; however, your actual return on that equity is completely tied to what the housing market does. As many are now painfully aware these days, equity can certainly be lost. With only a 7-year occupation timeline and the continued uncertainty of the housing market my vote would be for the IO loan.
I certainly believe the housing market will correct itself within the next 10 years; however, if the recovery is late to bloom, under which loan do you believe you will be more financially secure? I know which one I would pick if my timeline were 10 years of less!