I’ve been reading numerous gloom and doom blogs lately regarding the housing market and ARM loans that are about to wreak havoc on the economy so I decided to write about my experience with an IO ARM and the beneficial effects it has had for us.

First a bit of background, we purchased our first home in 1999 and because it was the glory days of the dot com boom, interest rates were high. Like everyone else, we were told that a conventional 30 year mortgage with fixed interest rate was the way to go so we signed on. We ended up getting a rate of 7% on a 30 year fixed loan and we made our payments diligently each month.

As the years passed we saw that a very tiny portion of the actual principal was getting paid down and most of what we were paying was interest on the loan. Looking at the amortization table, I realized that it would take about 8 years before our payments actually started to get the principle down.

When the dot com bubble burst, the fed began lowering rates. Sept. 11 attacks made things worse and the fed kept lowering rates. It was around the time when Fed rates were at 1% that I began to seriously wonder why I should continue to pay 7% on a loan when rates were much lower. I dug through the numbers a little deeper and realized a few interesting things:

  • Our biggest tax break came from deducting interest on our home loan
  • Since very little principle was being paid on our loan anyway, why not cut our payments in half with an Interest Only ARM, save the extra money and use it later to make a huge principle payment.
  • If we would eventually move anyway, why have a 30 year loan?
  • Our income levels continued to grow and we could easily afford to pay the 7% loan but why not start leveraging cash flow?

I did the math and these are the numbers (courtesy of www.dinkytown.net):

30 Year Fixed @ 7% Interest Only ARM @ 3.25%
Payment # Payment Balance Payment Balance
$100,000 $100,000.00
1 $665.30 $99,918.03 $270.83 $100,000.00
2 $665.30 $99,835.59 $270.83 $100,000.00
3 $665.30 $99,752.66 $270.83 $100,000.00
4 $665.30 $99,669.25 $270.83 $100,000.00
5 $665.30 $99,585.35 $270.83 $100,000.00
6 $665.30 $99,500.96 $270.83 $100,000.00
7 $665.30 $99,416.08 $270.83 $100,000.00
8 $665.30 $99,330.71 $270.83 $100,000.00
9 $665.30 $99,244.84 $270.83 $100,000.00
10 $665.30 $99,158.47 $270.83 $100,000.00
11 $665.30 $99,071.59 $270.83 $100,000.00
12 $665.30 $98,984.21 $270.83 $100,000.00
13 $665.30 $98,896.32 $270.83 $100,000.00
14 $665.30 $98,807.92 $270.83 $100,000.00
15 $665.30 $98,719.00 $270.83 $100,000.00
16 $665.30 $98,629.56 $270.83 $100,000.00
17 $665.30 $98,539.60 $270.83 $100,000.00
18 $665.30 $98,449.11 $270.83 $100,000.00
19 $665.30 $98,358.10 $270.83 $100,000.00
20 $665.30 $98,266.56 $270.83 $100,000.00
21 $665.30 $98,174.48 $270.83 $100,000.00
22 $665.30 $98,081.86 $270.83 $100,000.00
23 $665.30 $97,988.70 $270.83 $100,000.00
24 $665.30 $97,895.00 $270.83 $100,000.00
25 $665.30 $97,800.75 $270.83 $100,000.00
26 $665.30 $97,705.95 $270.83 $100,000.00
27 $665.30 $97,610.60 $270.83 $100,000.00
28 $665.30 $97,514.70 $270.83 $100,000.00
29 $665.30 $97,418.24 $270.83 $100,000.00
30 $665.30 $97,321.21 $270.83 $100,000.00
31 $665.30 $97,223.62 $270.83 $100,000.00
32 $665.30 $97,125.46 $270.83 $100,000.00
33 $665.30 $97,026.73 $270.83 $100,000.00
34 $665.30 $96,927.42 $270.83 $100,000.00
35 $665.30 $96,827.53 $270.83 $100,000.00
36 $665.30 $96,727.06 $270.83 $100,000.00

The totals are shown in the table below

Total Interest Paid Total Principle Paid Total Interest Paid Priciple left
on 7% Fixed on 7% Fixed on 3.25% IO ARM on 3.25% IO ARM
$23,950.80 $3,272.94 $9,749.88 $100,000.00

As you can see from the table, with a 7% Fixed Mortgage on 100k, we would have paid ~ $24k in interest and only paid down $3300 in principle on the loan. With the IO ARM however, we would have paid $9749 in interest and nothing on prinicple of the loan.

The advantage of the IO ARM:

  • We paid less in interest overall
  • We paid less in monthly mortgage payment (about half)
  • We managed to save the difference of about $14k

The skeptics will argue that we didn’t gain any equity via paying down the principle. Big whoo! We saved 14k! We can take the 14k and make a HUGE payment on the mortgage of 14k vs the 3k we would have with a fixed loan. This was a no-brainer and we were fortunate to have been able to take advantage of ultra-cheap money!