My wife and I are looking at refinancing. We have narrowed in on a 7/1 ARM and a 7/1 Interest Only.
When it comes to reducing the principal amount of the loan over the 7 years, is it better to go with the 7/1 ARM (automatically paying down principal) or go with the 7/1 IO and make additional principal payments?
Answers | 3
Thanks for your question. You actually touch upon a very common theme in finance and that theme is "discipline". Having served hundreds of clients over the years, I have found that if given the opportunity to pay more or less, most of us will pay less. That's probably just human nature, but you have to be honest with yourself and ask, "Am I disciplined enough to take the IO product and still make those principal payments?" If you are then, more power to you and go right ahead.
Another thought I might add is that depending on your income the IO product may fit better for your needs. If for example you are self employed or in a business where the income is erratic and not steady every month, you will have some relief only being obligated to an IO payment for some months out of the year, rather than the full P&I payment. However you will have to make additional principal payments in order to "catch up" on your principal reduction schedule.
Hopefully your loan proposal does not have a pre-payment penalty associated with it which would mean that for either product, you could pay additional principal at any time. The bottom line is that if you are disciplined & consistent enough, you'll reduce the principal on the IO product just the same as you would the P&I. Best of luck.
The answer to your question depends on two things: the difference in pricing between the two loan options, and (as Chad noted) , the likelihood of you actually making those voluntary principle payments. Presuming your income is sufficient to do the fully amortized loan, and the pricing is significantly better on the fully amortized payment, I'd opt for that. If you potentially need those principle payments for business capital, the I/O route may be best.
Glad to help if you have more questions, I write loans nationally, feel free to contact me through my profile,