I have to clarify a few things about my answer up front. I see this question and I think to myself that it is really about pre-payment penalties….since the interest only feature on a loan will not (by itself) stop you from refinancing. Therefore I will discuss pre payment penalties then move on to interest only loan features.
Pre-payment penalties have been common in recent years particularily on loans that offered a slightly better rate than the same terms without a penalty. This allowed them to guaranty to the investors that the borrower would stay in the loan for a set period of time. Most pre-payment periods were the same as the ARM reset periods (most were some sort of ARM loan) or 5 years on a 30 year fixed. So many borrowers styed in their loans to avoid the penalty and refinanced at the reset without penalty.
Now on interest only loans, the interest only portion could be the same or longer than the ARM reset or be 10 or 15 years if the underlying product is a 30 year fixed. After the initial I/O period the loan is then amortized for the remaining term.
So for example if you are 4 years into a 5 Year I/O then in one year your loan will become principle and interest over the remaining 25 years.
So that may be a good time to look into refinancing.
We always council that you take into account your whole debt structure when considering a refinance, and look into making adjustments that will 1.) lower your debt service dollars (money spent on all debts each month) 2.) increase your tax benefits if applicable and 3.) increase your liquid (short term) reserve and retirement (long term) financial picture. – Using the same dollars.
The best use of an interest only loan is not to have lower payment on your home and spend the difference on other goodies, but to PAY yourself the principle you are not paying the bank.
I recommend putting your mortgage under management today and you will easily be able to track your loans performance!
Hope that helps!
As far as refinancing your interest-only mortgage is concerned, you can take as long as you want. The important question, though, is “When does it make sense to refinance my interest-only loan?” The answer to that depends on alot of things.
First of all, one thing I’d like to clarify is that “interest-only” is not really a type of loan — it’s more of a loan feature; and there are lots of different loans with an interest-only feature. For instance, there is a 30-year fixed loan with a ten year interest-only feature. Typically, that loan allows you to pay just interest on your loan for ten years. If you still have the loan at the end of ten years, you payment increase to the point where it will be enough to fully pay off the loan over the following twenty years. In that case, the increase in payment resulting from the loan changing from interest-only to amortizing might be a reason that you would want to refinance.
There are also adjustable rate mortgages that have an interest-only feature. For instance, someone might have an interest-only 3/1 ARM. At the end of three years, the rate could go up or down. However, the interest-only period might be longer. Hence, because of the interest-only feature, the payment might still be attractive even if the rate went up some.
There are so many different factors to consider in determining whether to refinance that the best advice I can give you is to get a copy of your mortgage note. Seek out the advice of a good loan officer and bring a copy of the note to your consultation appointment. Taking into account the terms of your note and your financial goals, your loan officer will be able to give you a good idea about when it would make sense to refinance.