A self-amortizing loan has a payment large enough to both cover the monthly interest expense on the loan and to repay the principal balance over the life of the loan. In the early years of a self-amortizing loan, most of the monthly payment goes toward the interest expense.

Each month the interest expense goes down by a little bit and the principal payment goes up a little. With an interest-only loan, the monthly payment is equal to the monthly interest expense. You’re not paying down the loan balance at all. The typical interest-only loan converts to a self-amortizing loan 10 years in to its 30-year final maturity. At that point in time you’ll have a much higher monthly payment because you only have 20 years to pay off the principal balance.

Interest-only loans didn’t appear to have any drawbacks when housing prices kept rising. Homeowners built equity with price appreciation instead of with principal payments. In a softening real estate market, you can face risks with these loans that you wouldn’t face with a 30-year fixed rate mortgage.

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For more information on this and other real estate matters, your first source for Palm Beach real estate should be licensed agent and long-time resident Caesar Parisi.

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