Does an Interest-Only Mortgage Amortize Faster?
Here is a typical loan officer pitch for
an interest-only (IO) mortgage as related to me by countless borrowers:
on the 30-year 5.5% fixed-rate mortgage is $567.79 for each $100,000 of
loan, of which only $109.46 is reduction of principal. On the IO, the
rate is 3% and the payment only $250. If you make the $567.79 payment,
$317.79 of it will go for principal. This means that you will pay off
your loan much sooner.”
Everything in this statement is true,
yet it is extremely misleading. The rate on the IO is not 3% because it
is IO but because it is an adjustable rate mortgage (ARM). Rates are
lower on ARMs than on FRMs because ARMs are riskier to the borrower. The
real choice that is being made here is not between IO and non-IO but
between FRM and ARM.
Borrowers making this choice do indeed
have the option of taking the lower-rate ARM while making the larger
payment. This is a good risk-reduction strategy when selecting an ARM
because, if the ARM rate rises in the future, the payment increase won’t
be as large. ARM borrowers can adopt this strategy, whether their ARM
has an IO option or not.