Next week merits a mark on the calendar with an announcement from Fannie Mae (Stock Quote: FNM) that it’s severely curtailing the availability of interest-only loans. Does that pave the way for the end of such loans? And what do the rules look like? Let’s take a look.
First off, let’s define an interest-only loan. Basically, it’s a mortgage where the borrower pays only interest for a fixed term. At the term’s end (usually five to 10 years) the loan converts to a fully amortized loan in which both interest and principal are paid. In other words, an interest-only loan means just that — the entire mortgage payment during that timeframe goes toward “interest only” — and not the loan principal.
The benefits to the borrower are lower payments early in the loan. That would help a young income earner whose salary will rise over time to “grow” into the higher mortgage payments down the road. Consider a $417,000 mortgage with a loan at 5% interest. With a traditional 30-year-fixed loan, the monthly payment would be $2,339. But with an interest-only payment, that monthly payment falls to just $1,738. (A tip: to calculate your potential monthly mortgage payments, use BankingMyWay’s Mortgage Loan Calculator.
The downside is that, by reducing early mortgage payments, interest-only loan borrowers will likely owe more money over the total course of the loan.
But the upside/downside issue may not matter any more. On June 19, Fannie Mae is going to put the interest-only loan in a major vise. On that date, all interest-only mortgage loans must fit the following criteria (from the Fannie Web site):
- The home must be a one-unit property.
- The home must be a primary residence or vacation home.
- The mortgage must be a purchase, or rate-and-term refinance. No “cash out” allowed.