An interest only mortgage features monthly payments that only cover the interest and don’t include repayment of the principal loan amount. The principal is refinanced or repaid by the end of the term. Many real estate investors like interest only mortgages because they have very low monthly payments despite having mortgages rates between 6 – 15%.
LendingHome is a reputable online nationwide lender that offers an interest only mortgage specifically for real estate investors. They offer competitive rates for prime borrowers. Visit their site today and get pre qualified in just a few minutes.
4 Types of Interest Only Mortgages
|Hard Money Loans||Fix-and-flip investors who want to compete with all-cash buyers.|
|Balloon Mortgages||Investors who won’t qualify for a conventional mortgage or who are planning to refinance within a few years.|
|Bridge Loans||Investors who need immediate, short-term financing to take advantage of a great deal.|
|Seller Financing||Investors who want to buy multiple properties at the same time without debt-to-income requirements.|
The four types of interest only mortgages are:
1. Hard Money Loans
A hard money loan, also known as a fix-and-flip 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.
A hard money loan is right 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. It offers investors a chance to purchase a property that a typical bank wouldn’t finance.
Examples of When Hard Money Loans Are a Good Fit
Investors will be able to get financing based on the After Repair Value (ARV) of the property. The principal of the loan doesn’t need to be repaid until the term is up. If there are no prepayment penalties, you can pay off the loan when you flip the property.
A rent and hold investor will use hard money 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 Rates & Costs
Hard money loan interest only mortgage rates and costs include:
- Interest Rate: 6.99% – 15%
- Points: Upfront, which ranges from one to eight percent of the loan
- Appraisal: Generally $500
The cost of an interest-only loan varies by lender, but it generally includes the interest only mortgage rate, lender fees described as points, and an appraisal.
Hard Money Loan Terms
Hard money loan terms are generally:
- Repayment Term: One to five years
- ARV: 65% -75%
- LTV: 80% – 90%
Hard Money Loan Qualifications
Hard money qualifications include:
- Credit Score: 550+ (check your credit score for free here)
- Real Estate Experience: Prior experience with similar projects
- Down Payment: Typically 20%
- Exit Strategy: Sale or refinance
The qualifications for a hard money loan vary, but are generally more lenient than conventional mortgage qualifications. However, national hard money lenders have certain criteria that they expect the borrower to meet.
Where to Get a Hard Money Loan
You can get a hard money loan from an online nationwide lender or a local private lender. Our nationwide list of hard money lenders offers lenders in every state and comes with an easy to use map to find your state and the list of hard money lenders.
2. Balloon Mortgages
Balloon mortgages are similar to hard money loans because 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 helps investors improve their cash flow and gives them a refinance option before the balloon payment is due.
A fix-and-flip investor would use a balloon mortgage 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 and are expecting a pay increase or plan on selling before the balloon is due.
Balloon Interest Only Mortgage Rates & Costs
Balloon mortgage rates and costs include:
- Interest Rates: As low as 6%
- Balloon: Due once the term has come to an end
- Appraisal: Generally $500
- Fees: Any loan origination fees
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. Interest rates may have also changed during this time period, and this needs to be factored in when considering if a balloon mortgage makes sense for you.
Balloon Interest Only Mortgage Terms
- Term: Short, typically five to seven years
Although the loan is short term, the payment is based on 30 years.
Balloon Mortgage Qualifications
Balloon mortgage qualifications include:
- Credit Score: 580+, but over 620 is preferred (check your credit score for free here)
- Down Payment: As low as 5%
- Exit Strategy: Cash windfall, sale or refinance
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 generally more lenient than for a conventional loan.
Where to Get Balloon Interest Only Mortgages
You can find a balloon mortgage through some banks and credit unions, as well as online lenders. Start with the bank or credit union you have a banking relationship with because they usually offer the lowest cost for an interest-only loan.
3. Bridge Loans
A bridge loan is a temporary loan 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. 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.
Bridge Loan Rates & 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 and costs include:
- Interest Rate: Generally 2% higher than the current market interest rate, so 6.75%
- Appraisal: Generally $500
- Fees: 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 hotels or apartment buildings.
Bridge Loan Terms
Terms for interest-only bridge loans are generally:
- Term: A few weeks up to one year
Bridge loans are considered interim financing, so always have short terms.
Bridge Loan Qualifications
The qualifications of a bridge loan include:
- Financial Standing: The means to pay two mortgages
- Equity: At least 20% in your current property
- Exit Strategy: Sale or refinance
- Income: No firm guidelines but enough to cover both mortgages and any debts
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. They generally don’t have a specific down payment amount and will use the home as the collateral.
Where to Get Bridge Loans
Bridge loans are considered a special type of financing, so they’re not offered by every bank or lender. A bank or credit union that you have a banking relationship with may provide a bridge loan to you. Online lenders also provide bridge loans.
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 W-2 employees.
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:
- Credit Score: Certain credit score determined by the seller (check your credit score for free here)
- Down Payment: Generally over 25%
- Exit Strategy: Usually refinancing into a conventional loan
Seller Financing Interest Only Mortgage Rates & Costs
Seller financing rates and costs include:
- Interest Rate: 6% – 10%+
- Appraisal: Generally $500
- Fees: No loan origination fees or upfront points are due with seller financing
Seller financing rates and 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. The costs 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 Interest-Only Terms
Interest-only loan terms for seller financing are:
- Term: 1 – 10 years
The term, like everything else pertaining to seller financing, can vary but is rarely more than 10 years.
Where to Get Seller Financing
Seller financing is obtained from the seller of the property. A good tip is to ask for seller financing in the beginning of the negotiation process. You don’t want to agree on a purchase price, order an appraisal and then, at the last minute, let them know you need seller financing.
How an Interest Only Mortgage Works
An interest only mortgage works when a borrower obtains a loan and only pays the interest on that loan during the duration of its term. Interest-only payments are generally made monthly for a set period of time. The principal isn’t repaid until the end of the term of the loan. This lets the borrower get a loan they may not otherwise qualify for or be able to afford.
There are generally four types of interest only mortgages that can be used in different scenarios, such as to quickly purchase and flip a home, to compete with an all-cash buyer, and to purchase multiple properties at once. The interest only mortgage rates vary throughout the types of loans but are generally six percent to 15 percent, with terms of a few weeks up to 10 years.
“In a hot and quickly-rising real estate market, an investor may speculate by obtaining interest-only loans against as many properties as possible. The interest-only loan provides the lowest possible payment and allows the real estate investor to spread their capital and maximize their leverage.” – Jeffrey Hensel, Broker Associate, North Coast Financial
Pros & Cons of an Interest Only Mortgage
Now that we’ve discussed all four types of interest only mortgages, we will review the advantages and disadvantages of each so you can see if investor interest-only loans are right for you. Generally, interest only mortgages fit short-term situations for both consumers and real estate investors.
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
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
“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.” – Jeff Miller, Real Estate Agent & Investor, AE Home Group
Interest Only Mortgages vs. Principal & Interest Mortgages
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.
Frequently Asked Questions (FAQs)
Do You Build Equity with an Interest-Only Loan?
The answer is it depends. You’re not paying anything towards the principal of the loan, so you’re not building any equity that way. However, if the home appreciates in value or you renovate it, you can still build equity.
What Is the Interest-Only Period?
For investor interest-only loans, the entire term is interest only. However, some loans have a period of time that’s interest only and then the remainder of the term, you pay principal plus interest. At the end of the interest-only period, you will owe the same amount that you owed at the beginning of the term because you’re not paying down the principal.
Do You Have to Pay Off the Principal in an Interest-Only Loan?
The answer is yes, eventually you will have to repay the principal of the loan. This happens at the end of the loan term and you repay the principal of investor-only loans by selling the property, refinancing into a conventional loan, or paying it off with cash.
What Risks Are Associated with Interest Only Mortgages?
There are several risks associated with interest only mortgages, which include not being able to afford the monthly payment once the interest-only loan ends and you now have a conventional loan. Another risk is not being able to sell the property and owing the balance of the interest-only loan. A third risk is if the property doesn’t appreciate and you have no equity in the property.
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 for how the principal will be paid off.
If you are looking for a lender with interest only mortgages, contact LendingHome. They offer competitive interest only mortgage rates and they’ll lend up to 90 percent LTV and 75 percent ARV. Get prequalified online in just a few minutes.