A good friend closed on land and a building loan today. He was telling me about the loan process and some of the terms of his building loan/mortgage. It had terms that I hadn't run across before, but they were interesting terms.
The loan is fixed rate, 30 years, but the payment increases after 10 years. It's not a negative amortization loan or an interest-only loan for the first ten years. Principal is still paid back with each payment, but not as quickly during the first ten years. Basically, the payment schedule is fixed payment for the first ten years, followed by a conventionally-amortized 20-year loan on whatever principal remains after ten years.
As an example, let's say the loan was for $300k at a fixed rate of 6%. The amortized payment on this loan on a 30-year schedule would be $1,798.65. A total of $347,514.00 in interest would be paid over the life of the mortgage.
Now, let's instead pay only $1,600 for the first ten years. The principal still goes down to $283,612.02 during that period, and $175.612.02 in interest is paid. Now, to finish out the loan, we amortize $283,612.02 over 20 years at 6%. This gives a payment of $2,031.88. The interest paid during this second leg is $204,039.18, for a total of $379,651.20, which is $32,137.20 more than the conventional 30-year schedule.
Here is a plot of the two options:
The cost of the lower payment initially is more interest over the life of the mortgage, as can be expected. The fixed rate is a very good feature because it removes the rate risk from my friend.
From the bank's perspective, they're getting more interest income, and the payment “shock” ten years out is only 27%, which is not pleasant but way more manageable than if the rate were variable, or even if the first 10 years were interest-only. Plus, if the housing market tanks, the principal balance outstanding is still decreasing with time. Additionally, this loan is likely not a sub-prime loan, and can be sold by the bank more easily.
Has this kind of loan been around or is it new? I don't really know.
This is a cool concept. If your friend can be discipled and increase their own payment amount by 2% a year in each of the first ten years, they will have very little increase in payments by year 11.
Just a question: why? If you are buying a $300,000 house, why concern yourself with saving a mere $200 a month with funky terms that only benefit the lender? Then in 10 years you are paying $450 extra for the same loan.
Why make things more confusing? Now a 30 year fixed rate loan might not actually be a regular 30 year fixed rate loan?
It should be classified as a different type of loan, as borrowers could easily be misled here.
Really, I thought the whole idea of getting a great mortgage was paying as little to the lender as possible, not being thrilled about paying more.