How interest-only mortgages differ from conventional loans

Daily Democrat - Woodland, CA

Unlike a conventional 30-year mortgage, interest-only loans don't require payments toward the amount anywhere for the first three to seven years. After that initial grace period, borrowers face much higher monthly payments.

In contrast, a conventional 30-year mortgage with a fixed rate spreads the financing costs evenly over the life of a loan - a formula that generates higher monthly payments during the first three to seven years.

The two different approaches can make a big difference, particularly in expensive housing markets in the San Francisco Bay area, where large loans are required to close deals.

A conventional 30-year mortgage for $650,000 with a fixed rate of 5.625 percent would require monthly payments of $3,742, according to Michael Harrington, president of Summit Mortgage Advisors in San Francisco. An interest-only loan with a fixed rate of 5 percent for the first five years of the mortgage would require monthly payments of $2,708 during the first 60 months.

In the first five years of the loan, the borrower with the conventional mortgage would pay a total of $224,520, lowering the outstanding debt to about $602,000. The borrower with the interest-only mortgage would have paid $62,000 less during the same time, but still would owe $650,000, or $48,000 more than the borrower with the interest-only mortgage.