An interest only mortgage is one where the monthly payments only cover the interest and don’t include repayment of the principal. The principle is repaid in full at the end of the term, making them a good option for fix and flip investors. Interest only loans can also finance renovations and are good for both short- and long-term rehab investors as well as individual consumers.
Interest only loans are a good option for fix and flippers and those financing rehabs. LendingHome can provide interest only loans in as little as 15 days. Their rates start at 7.5% and they’ll lend up to 90% LTV and 75% ARV. Prequalifying online only takes a few minutes.
4 Types of Interest Only Mortgages
When deciding if an interest-only mortgage is right for you, you need to consider the different types available. Hard money loans are ideal for investors. Balloon mortgages, bridge loans, and seller financing are used by both investors and consumers.
Here are the 4 types of interest only mortgages:
1. Hard Money Loans
A hard money loan is a short term, interest only mortgage that funds fix and flip and rehab projects. It’s not fully amortized and the principal isn’t due until the end of the loan term. It offers real estate investors a chance to purchase a property that a typical bank wouldn’t finance.
Who Hard Money Loans Are Right For
A hard money loan (aka a fix and flip loan) is ideal for real estate investors who plan to either fix and flip the property or rent and hold the property that needs rehab work.
A fix and flipper uses a hard money loan to take advantage of the interest only payments to keep the carrying costs down while the property is under construction. They will be able to get financing based on the ARV (After Repair Value) of the property. The principal of the loan doesn’t need to be repaid until the term is up. If there aren’t pre payment penalties, you can pay off the loan when you flip the property.
A rent and hold investor will use hard money in two different ways. The first is as a rehab loan when the property needs more repairs than a conventional lender will allow. This loan will be based on ARV. Once the borrower makes the repairs and rents out the property, they will refinance it into a conventional loan to pay off the hard money loan.
There are two other reasons a rent and hold investor uses hard money loans. One is if the property needs to be seasoned (rented out for a period of time) to meet permanent financing qualifications. The other reason is to leverage the fast funding times of hard money loans in order to compete with all-cash buyers.
Hard Money Loan Qualifications
Hard money qualifications include:
- Credit score: 550+ (check your credit score for free here)
- Prior experience with similar projects
- 20% down payment (typically)
- A clear exit strategy (sale or refinance)
Hard Money Loan Rates, Terms, & Costs
Hard money loan rates, terms, and costs vary depending on the lender issuing the loan and the borrower’s qualifications.
Some typical hard money loan rates, terms, and costs include:
- ARV(After Repair Value) of 65-75%
- LTV(Loan to Value) of 80-90%
- 1 – 5 year repayment term
- Upfront points which range from 1-8 percentage of the loan
- The interest rate which ranges from 7.5% to 18%.
- An appraisal fee which is generally $500
If you are thinking of using a hard money loan to fund your next project, contact LendingHome. They will quickly prequalify you and their interest rates start at only 7.5%. Get funded in as little as 15 days.
2. Balloon Mortgages
Balloon mortgages are similar to hard money since they’re both interest only loans. However, a balloon mortgage is for a longer term and has a balloon payment (a lump sum repayment of outstanding principal) at the end. This longer term lets investors receive increased cash flow and a refinance option before the balloon payment is due.
Who Balloon Mortgages Are Right For
Balloon mortgages can be right for investors or consumers. A fix and flip investor would use a balloon mortgage in order to take advantage of lower interest rates and lower closing costs before flipping the property. A long term investor would refinance before the balloon payment is due.
Consumers may choose to use a balloon mortgage if they can’t afford the monthly payments of a conventional mortgage. A balloon mortgage may be the right option if they know they are going to sell their house within a few years, or if they’re expecting a pay increase and know they will be able to pay off the balloon when it’s due.
Balloon Mortgage Qualifications
In order to qualify for a balloon mortgage, you will need to be able to show how you intend to pay off the balloon at the end of the loan. Qualifications of a balloon mortgage are more lenient than for a conventional loan.
Balloon mortgage qualifications include:
- Credit score 580+, but over 620 is preferred (check your credit score for free here)
- A down payment as low as 5%.
- A clear exit strategy (cash windfall, sale or refinance)
Balloon Mortgage Rates, Terms, & Costs
The costs of a balloon mortgage are lower than a conventional mortgage initially, but the major costs come in at the end of the loan, which is the balloon phase. Although the loan is short term, the payment is based on 30 years.
Balloon mortgage rates, terms & costs include:
- Interest rates as low as 5%
- A short term loan, typically 5 to 7 years.
- A balloon which is due once the term has come to an end
- An appraisal fee which is generally $500
- Any loan origination fees
Balloon Mortgages offer lower interest rates than a borrower would qualify for with a conventional lender. They provide the borrower the opportunity to have low initial monthly payments and a low down payment, but those perks come with the cost of a balloon payment being due at the end of the term. Interest rates may have also changed during this time period, which needs to be factored in when considering if a balloon mortgage makes sense for you.
3. Bridge Loans
A bridge loan is a temporary loan to cover the time between two real estate transactions. A bridge loan is typically used to purchase one property before selling another property. It allows you to purchase the property without having a contingency to sell the other property.
Who Bridge Loans Are Right For
A bridge loan can be right for a real estate investor or a consumer looking for an immediate, short term financing option. An investor may use a bridge loan if they find an amazing property that won’t be available by the time they have the cash or financing in place. They use the bridge loan to purchase this property and can refinance it or sell it to pay off the bridge loan.
A consumer may use a bridge loan to purchase a new primary residence, before their current home has sold. If they find a home they want to move into but can’t get traditional financing on it they will use a bridge loan. A conventional lender may think the borrower can’t afford both mortgages or will only lend based on the contingency of the original home selling.
Bridge Loan Qualifications
A bridge loan has unusual qualifications compared to other more common loans. Bridge loans look less at a borrower’s credit and financial history and more at if the deal makes sense. The qualifications of a bridge loan include:
- The means to pay two mortgages
- At least 20% equity in your current property
- A clear exit strategy (sale or refinance)
Bridge Loan Rates, Terms, & Costs
Bridge loans are temporary and provide interim or quick financing for a certain window of time. They are specialty loan products so their guidelines vary widely.
Bridge loan rates, terms & costs include:
- An interest rate that is generally 2% higher than the current market interest rate
- A few weeks to a year term
- An appraisal fee that’s generally $500
- Loan origination fees of 1 to 2% of the value of the home
A bridge loan, also known as gap financing or a swing loan bridges the gap between debt coming due and the time it takes to put long term financing in place. This type of bridge loan is not to be confused with a commercial bridge loan which is used for bigger projects like a loan for hotels or financing apartment buildings.
4. Seller Financing
Seller financing is traditionally when a seller offers a buyer a principal and interest (fully amortized) loan on their property. Though, not as common, it can also be an interest-only loan. A self-employed buyer may opt for seller financing since traditional lending regulations are stricter for them than W2 employees.
Who Seller Financing Is Right For
A real estate investor may opt to use seller financing if they are purchasing multiple properties at once and know that a lender wouldn’t approve all of the deals. It’s also a good solution for a fix and flipper with less than ideal credit. It will allow them to purchase the property, fix it up, flip it and then pay back the seller, without getting a bank involved and oftentimes without it affecting your credit score.
Seller financing is generally used for consumers looking to purchase a primary residence. A seller may offer interest-only financing if they want to sell their home quickly and know the buyer would not immediately qualify with a traditional bank. A buyer with blemishes on their credit may choose seller financing until they repair their credit.
Seller Financing Qualifications
The qualifications for seller financing will be up to the seller to decide. They aren’t regulated by a bank or a private lender. The seller of the property is acting like the bank.
Seller financing qualifications include:
- A certain credit score determined by the seller (check your credit score for free here)
- A substantial down payment, generally over 25%
- An exit strategy which is usually refinancing into a conventional loan
Seller Financing Rates, Terms, & Costs
The conditions of seller financing are agreed upon by the seller and buyer of the property. They may also include an initial deposit to take the house off the market while the seller performs the due diligence on the buyer.
Seller financing rates, terms & costs include:
- An interest rate from 6% to over 10%
- A term of 1 to 10 years
- An appraisal which is generally $500
- No loan origination fees or upfront points are due with seller financing
Seller financing rates, terms & costs will vary the most out of all of the types of interest-only loans. They will be determined by a personal seller, instead of a lending institution, so they’re not regulated.
Pros & Cons of an Interest Only Mortgage
An interest only mortgage isn’t ideal for everyone. It fits certain, short term situations for both consumers and real estate investors.
Some of the pros and cons of an interest only mortgage include:
Pros of Interest Only Mortgages
- Lower monthly mortgage payments
- Purchasing a home that the borrower may not have otherwise been able to afford
- The entire monthly payment is tax deductible
- Freeing up cash flow to quickly invest in other properties
After seeing the pros of interest only mortgages, contact LendingHome to get a quick pre approval. They lend up to 90% LTV and 75% ARV and their competitive rates start at 7%.
Cons of Interest Only Mortgages
- The potential of rising interest rates if the loan has an adjustable rate
- Not being able to afford the principal payment when it becomes due
- A possible prepayment penalty if the borrower refinances the loan before it’s due
- The possibility that the property won’t appreciate as quickly as anticipated which could leave the homeowner owing more than the property is worth
Jeff Miller, a realtor and investor at AE Home Group warns of the disadvantages of interest only loans.
“There’s the risk of finding yourself underwater if the market was to dip. Interest only loans are a poor idea for long-term, cash flow rentals in a slowly appreciating market.”
Interest Only Mortgage vs. Principal & Interest Mortgage
An interest only mortgage differs from a principal and interest mortgage in that it only requires the borrower to pay off the interest on the loan. This is paid for a set amount of time until the principal becomes due. A mortgage calculator is a helpful tool to use when comparing mortgage payments.
A principal and interest mortgage is a more widely used financing tool. It’s less risky because no balloon payment will become due. The borrower pays both the principal and interest in each mortgage payment. In the beginning most of the payment goes towards the interest, but as time goes on, more of the monthly payment will be applied towards the principal.
The chart below illustrates the differences between a hard money loan, a balloon mortgage, and a conventional mortgage. To show you the differences, we assume a $100k purchase price and the average down payments, points and interest you can expect to see in each loan.
Hard Money Loan vs Balloon Mortgage vs Conventional Mortgage
|Property Purchase Price|
|Balance Owed at End of Term|
|Total Cost of Capital|
As the chart above shows, a hard money loan is a good option for fix and flippers with a short timeline that lowers carrying costs. A balloon mortgage allows investors to finance properties in a hot market that’s quickly appreciating. Their rent cash flow will increase because of the low monthly mortgage payments. A conventional loan is ideal for long term investors who want to build equity over time. For more information on hard money loans and nationwide lenders that offer them, check out our hard money lender directory.
Bottom Line On Interest Only Loans
An interest only loan is a beneficial tool for a short period of time under the right circumstances. Interest only mortgages include a hard money loan, a balloon mortgage, a bridge loan and seller financing. Before getting an interest only loan make sure you have an exit strategy in mind of how the principal will be paid off.
If you are looking for a lender with interest only solutions, contact LendingHome. They will prequalify you online in minutes. Their rates start at 7.5% and they’ll lend up to 90% LTV and 75% ARV.