How can I build equity with an interest-only ARM?

Question

I just purchased my first home in April with an interest-only ARM, with two separate loans (80% & 20% (to help avoid the PMI)). I'm not understanding how I'm building equity in my place when I'm only paying towards the interest of the two loans.

Also, I'm working on a plan to take any extra cash I have so I can pay down the higher of the two loans (the 20% loan of $37k @ 9.75%) so I can eliminate that loan altogether and lowwering my monthly payments by the $377 I'm paying towards that second loan. Am I on the right track with this idea? Has someone come across this before/have a better idea?

So I want to gain a better understanding of how paying interest-only is building equity AND I'm looking for ideas on how to make the most of the limited amount of cash I have on-hand.

Answer 1

There are only two or three REAL ways an I/O loan can build equity in your home (and it's not really the loan doing the work tbh.)

Equity is defined as a homeowner's financial interest in a property. Equity is the difference between the fair market value of a property and the amount still owed on the mortgage(s).

One is if your home appreciates in value over the coming months and years as the market itself climbs. Thus, if your home becomes more valuable and the amount of your loan stays the same, you receive "equity".

The second (and most dependable) way is if you make payments above and beyond the basic I/O payments. These additional amounts would be applied straight to the principal thus creating equity by paying down your loan. I would suggest sending a check that specifically states "Principal payment" in the memo field on the check just to make sure it gets applied appropriately.

The third way would be to upgrade your kitchens, baths, or anything in disrepair. But be careful of this method, because without proper planning and analysis, you could spend significant money for very little or no increase in value.

Hope that helped some.

Answer 2

Making the interest-only payment is not building any equity. Unless you make additional payments to the principal, the only equity you will get is from the property value appreciating.

Since you do plan on taking any extra money to pay off the higher interest second, you will be building equity there and it's the best strategy given your situation. Even assuming that the property values remain constant, once you have that loan paid off, you'll have 20% equity. At that point you can start using the money you would previously have paid on the second and use it to reduce the principal on the first (or, if the rate environment is right at the time, refinance onto an amortizing loan.)

Answer 3

Most loans like you are describing are interest only just as to the primary loan. The second loan you describe is most likely not interest only. Look in the closing papers or obtain an amortization schedule from the bank. Since it is a higher interest rate, I would pay an additional amount towards principal on the second loan until you have paid it off. You need to carefully read your "note" on the interest only primary loan. Some of these notes contain language which prevents payment towards principal during the interest only period. Look at a heading entitled prepayments during the interest only period. The language varies from note to note. Most people use this type of loan anticipate the value of the real estate to appreciate in value thereby building equity. Many would simply apply any prepayment towards the next payment due. While you have two loans, pay off the second 20% loan first.

Answer 4

The first two years on your loan you are paying nothing but the interest. Just a way the bank/lender stays they want there money for giving you the loan. Equity is built when the property values around your home go up. So Mr& Mrs Smith have a comparable (comp) home to yours and sell there home for 10,000 more than you bought yours a month after your purchase. Two months after your purchase Mr Brown has comparable home to yours sells his home for same price as Mr& Mrs Smith. You can use both homes a comps (comparables) and state you just made $10,000 in equity. This is a short example but I think you get the point. Comparables are good if they are in short distance to your home. 10 miles out probably not a good comp unless you live in a rural area.

Paying interest on the first and slamming the 2nd is a very good strategy. Again you are already paying the interest for the first two years on that loan anyways might as well shorten the 2nd so when the equity in your house builds over the 2nd you can refi rate/term into a single payment.

So for the next year to two years when you see a For Sale Sign in your neighborhood grab the flyer and see how much they are selling it for as long as the home is comparable to yours.

Hope this helped and congratulations on the new home.

Answer 5

I believe you are on the right track with this idea of paying off the 2nd note asap, then using the monies dedicated to that note to help pay down the 1st note. make sure when you send the checks in you send 2 SEPARATE checks with a note on the second that it is for principal only or your mortgage company may see it as advance payment on the next payment due. you do not build equity soley by paying down and interest only until you pay it off, rather you gain equity from appreciation.

Answer 6

first of all, wait till next week to confirm what the recent expenditures of activity are going to be. you go with to refi yet i might anticipate the fees to pass down...and that they're going to. do not rush. wait and notice....then i might do a 15 year mounted and set as much as pay bi-month-to-month. in case you may, upload additional money on your bi month-to-month fee....any approximately will help. this might cut back your money right down to approximately 7 years. the greater further on your fee might desire to placed you at approximately 5 years.