30 Year Fixed Rate Interest Only

The subprime market is imploding or exploding, depending on which side of the fence you are standing. The rumors circulating among homebuyers are that all interest only mortgages are risky and should be avoided. In many cases that may be true, but I think, more true, is a confusion among buyers about mortgage programs in general.An interest only mortgage is not a subprime mortgage necessarily. In fact, it's generally an option for only the most qualified buyers. It even makes sense for those who plan on prepaying the balance of their mortgage on their own. Why? Payment recast.With a 30 year interest only mortgage, the payment due each month is an interest only payment. So on a $400,000 mortgage at 6%, the monthly interest only payment is $2000, rather than the principal and interest payment of $2398.20, where $2000 is the interest payment and $398.20 is paying back the loan each month at the same 6% interest rate.If a well-qualified, disciplined borrower chooses the interest only option, and continues to pay the same payment as the fully amortizing payment, her payment will be reduced based on the new principal balance each month.Here's an example:Keiko, buys a $500,000 coop here in New York City. The coop requires a 20% down payment, so her mortgage is $400,000. She decides on a 30 year fixed rate interest only mortgage. Her first month's payment is $2000, but she pays $2398, indicating that the additional amount goes directly toward principal on her statement when she mails her payment. The next month, her payment is reduced to $1998.01 based on the new loan balance of $399,601.80. If she continues to pay $398 in addition to the interest only payment each month, at the end of the first year, her interest only payment will be reduced to $1976.11. If she chooses, she may elect to pay the interest only payment giving her the freedom to spend the difference in another manner (hopefully paying down credit card debt that's more expensive).Her payment is reduced to reflect the lower principal balance offering her immediate gratification for her discipline. A well disciplined borrower may welcome the freedom of being to either pay down the principal or put the money to use elsewhere on a month to month basis while having the security of a fixed rate for the life of the loan.