Applying mortgage acceleration to an interest only mortgage produces borrower benefits similar to when the strategy is applied to an adjustable rate mortgage (ARM) including lowering the required monthly mortgage payment, significantly reducing interest expense and reducing the length of the mortgage. The main difference between interest only mortgage acceleration and ARM acceleration is that interest only mortgage acceleration enables the borrower to reduce the required monthly mortgage payment during the initial interest only period.
The ability to reduce your required monthly payment by applying mortgage acceleration during the initial interest only period of the loan is unique to interest only mortgages
When the borrower overpays his or her mortgage during the initial interest only period, the overpayment reduces the principal balance of the mortgage. The lower the principal balance, the lower the interest expense and the lower the required monthly mortgage payment. So if the borrower overpays his or her mortgage during the initial interest only period his or her required monthly mortgage payment goes down every month.
Following the interest only period the mortgage converts into an amortizing adjustable mortgage, with the borrower paying both interest and principal, and the borrower can continue to apply mortgage acceleration.
Below we demonstrate how applying acceleration to an interest only mortgage enables you to lower your monthly mortgage payment in a steady or declining interest rate environment and control your monthly mortgage payment in a rising interest rate environment.
A unique benefit to interest only mortgage acceleration is your ability to reduce your monthly mortgage payment during the initial interest only period of the loan. So even though the interest rate does not change during the initial interest only period your required monthly mortgage payment will decrease every month that you overpay your mortgage. This is because during the interest only period your monthly mortgage payment is calculated based on the principal balance of your mortgage. When you accelerate your mortgage by overpaying every month you reduce your principal balance which results in a lower required monthly payment.
In the example below we compare an interest only mortgage with no mortgage acceleration (blue line on chart) to an accelerated interest only mortgage (green line on chart). For the accelerated interest only mortgage the borrower overpays his or her mortgage by $200 every month. Both mortgages in our example are $380,000 10/1 interest only mortgages with 30 year terms, which means the borrower is required to pay only interest and no principal for the first ten years of the loan. Both mortgages convert into amortizing adjustable rate mortgages for years 11 - 30 when the borrower is required to pay both interest and principal and the interest rate is subject to change annually. For the purpose of this example we hold the interest rates constant at 4.0% for both mortgages over the life of the loans. Although this is an unlikely scenario it makes comparing the two mortgages easier and illustrates the benefits of acceleration.
The example illustrates how overpayment results in a steady reduction in the required monthly mortgage payment (red line) during the interest only period (years 1 - 10) continuing through the adjustable rate period of the mortgage (years 11 - 30). The accelerated interest only mortgage also has a lower required mortgage payment when the mortgages convert into amortizing loans in year 11. This is because the accelerated mortgage has a lower principal balance due to steady overpayment during the ten year interest only period. Applying mortgage acceleration also results in over $39,000 in interest expense savings as compared to the non-accelerated mortgage.
Overpaying an interest only mortgage reduces the required mortgage payment even during the interest only period
Lower required monthly payment beginning in year 15 even with $200 monthly overpaymentOver $39,000 in Interest Expense Savings
Mortgage acceleration can also help you manage the monthly payment for an interest only mortgage in a rising interest rate environment. Overpaying an interest only mortgage during the mortgage's initial interest only period you can help protect against a significant increase in your required monthly payment if interest rates rise when the loan converts into an amortizing mortgage.
In the example below we show the benefits of applying mortgage acceleration when interest rates increase. In the example we use a $380,000 10/1 interest only mortgage with a 4.0% interest only period interest rate and compare an interest only mortgage with no mortgage acceleration (third column in table) to an accelerated interest only mortgage (fourth column in table). For the purpose of this example, the interest rate increases to 9.0% at the beginning of year eleven (a 5% increase in interest rate is possible but highly unlikely).
The borrower applies mortgage acceleration and overpays his or her mortgage by $200 every month during the initial ten year interest only period. Using mortgage acceleration enables the borrower to have a lower required monthly mortgage payment ($2,157 compared to $2,303) when the interest rate increases and the mortgage converts into an amortizing mortgage beginning in year eleven. Additionally, the mortgage balance at the beginning of year eleven for the accelerated interest only mortgage is $24,000 lower than the interest only mortgage with no acceleration. A lower mortgage balance means a reduced mortgage payment and less total interest expense over the mortgage term.
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