Should I get an interest only mortgage and invest the principal?

Question

I was talking with my boss recently about our mortgages, and I wanted to see if anyone else has done this.

I just bought my personal residence and have a 30 year loan for $322k at 4.65%.  He suggested that I get an interest only loan and take what I would be paying towards the principal and invest it in the market.  As long as my investment does better than 4.65%, I'm actually better off than paying down the loan.  I don't know a whole lot about interest only loans, and it sounds like the interest only aspect of it only applies for a portion of the loan repayment period and not the whole thing, so eventually you have to start making larger payments to cover the missed principal payments.  You end up paying the same amount if you let the loan go to term.

Anyway, has anyone else done this or is there something that I am missing, because an average of 4.65% seems very doable in the market, even with the volatility we have seen lately.

Michael Seeker · Answer

If you just purchased a house, then you'd have to refinance to get a new loan which will cost you money up front.  In addition, interest only loans are not nearly as common as amortizing loans and I suspect you'd have a hard time finding one with similar term structure as your current 30-year mortgage.

Now...IF you can some how manage to make the interest-only loan work, the bigger challenge is maintaining the discipline to invest AND getting consistent, 4.65%+ returns.

It's one thing to invest money when it's yours and you don't have to pay it back.  When you borrow money to invest, then you're one mistake or crash away from bankruptcy and losing it all.  I'd say steer clear of your bosses "advice".

Daniel Chang · Answer

I also think it's unwise.

Financially, it's sound...in theory.  If you have a loan at 4.65% and can CONSISTENTLY get anything about 4.65% on an investment, then overall you make more money by leveraging.  The key word is of course consistent.  A lot of people have forgotten the 2008 recession when all markets, stocks, bonds, real estate crashed.  No one can predict how an investment will turn out.

Furthermore, you not only have to achieve greater than 4.65%, you will need to achieve greater than 4.65% AFTER-TAX returns.  Depending on your tax bracket, that could be 7% or higher.

Overall, there's a lot of people like your boss and the RE community should be grateful.  They chase returns without understanding risk.  When the market turns, they are the ones that lose their properties so investors can pick up properties on the cheap.

Steve S. · Answer

Do not change to an interest only loan now. Rates are so low, inflation is so high. The current trend by the central banks is not sustainable. Hold on to your mortgage you have now. The savings will only a few hundred a month and like Michael Seeker said ... you will have closing costs that will take you months or years to recuperate from your refi. Totally not worth it.

If you have "real money" (tens of thousands) to invest now then just leverage it with Hard Money to get get your investments going. If you don't have "real money" now then your little amount per month from an IO vs. Full AM is not going to get you there.

Overall ... keep what you got and figure out other ways to get into the game. Best of luck out there.

Paul Stout · Answer

If by "market" you mean the stock market the answer is a resounding NO!  You will most likely not net over 4.65% over the term of your loan.  Even the best of the best can't guarantee this.  If anyone does, run from them as fast as you can.  If you do, great.  If you don't, you're homeless and your credit is destroyed.  Remember I said net.  Investing is a game of risk vs. reward.  The reward in your case does not and will not justify the risk.

Let's say you do this and for a year or two everything is going fine.  Then in the third year you lose 40%.  You will probably do what most people do and sell to guarantee your losses.  The stock market is ruled by those with no emotion.  It's hard enough to remove the emotion without something as emotional as your home tied to the money.

Now if you are talking about real estate then the answer is still no.  You would be much better off selling your home and moving into a multi unit and letting tenants pay off a large portion if not all of your mortgage.

Brent Coombs · Answer

@Paul Spangler, it also depends on whether you bought your own home for the "right" price ie. will it STILL be worth a lot more than $322k whenever the next GFC occurs - anytime within the next 30 years?...

Brian H. · Answer

@Paul Spangler - In my opinion, this would be unwise. Leverage is a tool that can injure you if not utilized expediently, with consideration given to both the risk and the reward. Have you put actual numbers to the reward? I'm guessing it will be very minimal. Have you given consideration to the risks?

That said, I think its great that you are looking at alternative financial strategies. Always an entertaining and educational process.

Should I get an interest only mortgage and invest the principal?

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