30 Year Fixed with Interest Only Mortgage

This is one of my favorite interest only mortgages for the right borrower.  Currently I'm working with a single Mom who is self employed.  Her income is usually pretty steady but it can fluctuate at times.   She's buying her next home and has enough funds from the proceeds of the closing of her existing residence to cover her closing costs and put 20% down.    She believes she will live in the new house forever.

Fannie Mae has added a nice feature to the old "meat and potatoes" stand-by, the 30 year fixed rate.   Now, it's available with the first 10 or first 15 years with interest only payments and the rate is fixed for the 30 year term.     Here's how current rates compare, based on the scenario I stated above:

30 Year Fixed Rate (No interest only option):  Note Rate 5.875% (APR 5.967%).  Principal and interest payment on a $300,000 loan = $1774.61.   At 10 years, the mortgage balance (with no additional principle paid) is $250,214 and at 15 years, the balance is $211,911.

30 Year Fixed Rate/10 Year Interest Only:  Note Rate 6.00% (APR 6.093).   Interest only payment on a $300,000 loan = $1500.00.    Assuming no payments are made towards principal for 10 years, the p&i payment at 120 months (amortized for 20 years at 6.00%) will be $2149.29.

30 Year Fixed Rate/15 Year Interest Only:  Note Rate 6.125% (APR 6.205).  Interest only payments on a $300,000 loan = $1531.25.   Assuming no payments are made towards the principal for 15 years, the p&i payment at 180 months (amortized for the remaining 15 years at 6.125%) will be $2,551.88.

There is a difference of $274.61 between the 10 year interest only and the fully amortized 30 year fixed rate.   If someone was planning on paying off their mortgage, they have the freedom to pay $275 a month towards principal and then they effectively have a 30 year fixed mortgage.    Or, they could also invest the $275 a month (a conservative interest bearing account at 5% would accumulate to approximately $44,300 in 10 years).

Another benefit about the 30 year fixed interest only mortgage is that you do not diminish your mortgage interest income tax deduction since your mortgage balance does not change.   Yes, you will have a higher balance when the interest only period is over and a higher payment when the mortgage is re-amortized, assuming the mortgage is not refinanced.   If the mortgage is not refinanced, it is most likely because the rate that was obtained 10 -15 years ago is more favorable than rates at the adjustment time.   

Most people will not retain their mortgage for 30 years.   Truth be told, they will either refinance or sell their home.   Flexible payments (no negative amortization) with the security of knowing  you have a fixed rate for a long long time...ahhh...piece of mind! 

I will continue to spotlight various mortgage programs on this blog.   Borrowers should always consult with their Certified Mortgage Planning Specialist before selecting their mortgage strategy...my little disclaimer.

Update  7/23/2007:   Conforming interest only fixed period mortgages are now qualified at the fully amortized PITI payment.