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interest free loan question

A friend gets interest free loans on smaller properties and then pays them off as soon as possible.

He says that by doing this, he saves a ton of money and that the bank gets hardly anything.

(Just wondering if someone else can confirm this.  I'm looking for some numbers to back this up.)
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December 27 2010 - Laguna Niguel
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If he gets loans interest free why would it matter how quickly he pays it off? I'm not understanding the question....

Also, there is no bank in this country that would give away a loan interest free. Maybe your friend said something else? Interest ONLY maybe???

Greg
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December 27 2010
Profile picture for scubacuda
I'm sorry, my bad..."interest only loan".

(That is a stupid question without that piece)
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December 27 2010
He is saving interest charges by paying back the loan as soon as possible.  Whether or not this is the best way for him to "save a ton of money" is a completely different question.

The fact that his mortgage allows for interest only payments is not relevant to "saving a ton of money" because he is obviously paying the loan down faster than the minimum interest only payment requires.  In fact, it may be that his interest rate is higher than it would be if he had originated a mortgage that required a full principal and interest payment.  In this case, his interest only mortgage is probably a bit more expensive than a standard mortgage. 



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December 27 2010

Does he do this on investment properties or on homes that he lives in? Either way paying off real estate as quickly as possible is one of the worst investment strategies there is. Primary residence, investment property, interest only, or otherwise.

Lets also look at getting an interest only loan for the purpose of paying it off as quickly as possible. Assuming paying it off wasn't a bad idea using an interest only loan to achieve that goal is also counterproductive. An interest only mortgage has a HIGHER interest rate than a mortgage where principal and interest payments are required. So, in getting the interest only loan he ends up paying more in interest and it takes him longer/more cash to pay off the loan. It makes absolutely no sense if paying off the loan is the primary goal and reason for the IO loan in the first place.

That isn't to say an interest only loan is a bad choice for everyone, it isn't, it's a great tool for some investors to manage cashflow. But for the person (foolishly) trying to pay off the mortgage as quickly as possible, it's about as bad a decision as they can make due to the higher interest rate.

Hope this information helps...

Sincerely,
Greg

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December 27 2010
Greg,

You stated: "Either way paying off real estate as quickly as possible is one of the worst investment strategies there is."  Though this is a correct statement most of the times, I would argue that you need to look at each situation individually and that the key issues are: what is the (tax-adjusted) rate that you are paying on the mortgage?  what is the expected return on the next best use of the funds that you would be using to pay down the mortgage? Is there value to you for keeping these funds liquid rather than locking them into equity in a property?
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December 27 2010
Profile picture for sunnyview
I would not recommend an interest only loan on a primary residence. They have gotten a lot more people in trouble than they have helped in my opinon. Your investor friend is rolling the dice, hoping that rents will hold, that rates will stay low for a future refinance if needed or that the property will go up in value before the rate resets.

Not a good or safe bet in this market. You can get decent cash flow without all that risk. I would avoid his stacking strategy because when it fails, it fails big time.
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December 27 2010
Profile picture for the_country_hick
Interest only loans along with Adjustable Rate Mortgages are the biggest reasons we have the foreclosure mess today.

Once the interest only loan resets so you have to pay principle also very often the loan is unaffordable.

If you are thinking you could always refinance it later, look at today. Many others thought the same thing. They could not refinance the house but could lose it to foreclosure.

Seriously, look at different time frames. 15, 20, 25, or 30 years. But always go fixed rate. That means you pay off both interest and principle owed with every payment. Except for increases in taxes and insurance your monthly payment will not change for the life of the loan. Nothing is worse than having an affordable loan suddenly become unaffordable.
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December 27 2010
Profile picture for STINAIKAR
Does any lender offer IO's? I havent come across any.
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March 14 2012
Yes, many lenders offer I/O loans, they are most common on Jumbo Arms. 
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March 14 2012

Yes, many lenders still do.

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March 14 2012
 
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