Interest only loan for property?

Question

Answer

@Tiffany Davidson, hi and welcome to BP! @Jaysen Medhurst gave you some good advice. I will expand on it a bit. One common usage of interest only is with hard money loans. Hard money loans simply mean a loan that is backed up by a "hard" assets (i.e. real estate). It's not some mobster with a collection agent named Guido. The hard money lender wants to put his money to work and earn a steady cash flow, then get his principle back. He doesn't want to mess with amortization schedules where part of the payment is principle and part is interest. He wants all interest. Example: $100,000 loan at 12% APR. He wants to get $1,000 per month interest payment until the entire principle is repaid, which is typically a shorter period of 3-12 months during which time the investor is fixing up the property so he/she can turn around and refinance it onto a long-term, self-amortizing loan. As Jaysen said, the interest only loan carries significant risks, but it does have it's uses. One of the most common risks is rash or overeager investors will overpay for a sub-par property thinking that just because they got the monthly payment down the property is a good deal. That's dangerous. Never use the ease of the monthly payment as an excuse to purchase a property that otherwise is a poor performer, unless you have a fast and realistic plan to turn it into a good performer very quickly. A lot of home owners in the years leading up to the sub-prime meltdown had interest only loans and bought houses they couldn't afford when it came time to refinance and get onto a regular amortized loan. They assumed the value of their home would always go up where they could refi in a few years for no money out of pocket, and in the meantime they could just pay less and ride the wave of eternally rising property values up. You see where it got them. I hope this helps.

Answer

@Tiffany Davidson It depends on what you are trying to do and how long you plan on owning the property. An interest only loan increases your monthly cash flow because you are not paying down principle. 100% of the payment is interest. If you are holding a property for a short amount of time (up to 10 years), there is nothing wrong with an IO loan. When you sell the property, you will pay off the original loan and hopefully make money because of appreciated sales price. If you plan on holding the property for retirement, you wouldn't want an IO loan because ultimately you want to pay off the mortgage and live off the rental income without having to make mortgage payments.

Answer

To @Mike Burkett et al:Do I need to pay down a mortgage for my retirement strategy?: I don't have any heirs to whom to leave my properties. Because of my low income on paper, the only loan for which I can qualify now or in the future is an asset-based one, thus, in the future I wouldn't be able to easily access the equity through a HELOC or refi.The only debt I will have is 5 mortgages; I live rent-free in a room in one of the 5 properties; and the section 8 guaranteed rents for 4 of those, plus the reliable short-term rents from the high-end rooming house, cover the debt service and will cash flow $84,000 (or a proportionate value as rents and expenses rise) for the next 10 years, at which time I'll be 61. After 10 years, I'll pay P&I at the same interest rate for the next 30 years; even with that increased PITIA, I will be able to live off of the cash flow comfortably. Is this a sound strategy for my current semi-retired and future retirement living? These rental properties are my only source of income and I have about $20,000 in an IRA. Pre-Covid, my plan was to live part-time overseas to stretch my U.S. rental income dollars. I have no kids or spouse so I have to make sure I have enough money to afford home health care and housekeeping to avoid being shipped to the old folks home!I would truly appreciate everyone's feedback on this plan!

Answer

Yes, I’ve used interest only mortgage when a great beachside house I had under contract was hit by hail before closing. We used the IO product because the roof and a window was now damaged. Took the time to renovate that damage while in a one year “bridge loan,” on the way to a regular 30 year mortgage.

Answer

An interest only loan is often associated with bridge financing/hard money loans. Other commercial loans can sometimes have an interest only period for a certain time. For example, you might have a 10 year Freddie Mac loan on a multifamily property with 3 years of IO.

Answer

Good points, @Erik Whiting. I wasn't thinking of HML.

Answer

@Tiffany Davidson, Interest Only mortgages (or a proportion thereof) only really make sense in two instances.When re-positioning a property an IO period at the beginning of a mortgage will maximize cash flow. This makes it easier to sustain the property when units might be down and income reduced for remodel, etc.In rapidly appreciating markets when the hold time will be short. This is very speculative and risky. Generally, a pretty bad idea.