I’m not sure if you’re aware of this detail (it was left out of the OP), but it’s not really a “5 year interest only”.
If I’m reading you right (and I remember correctly from when I was going through this), that means that your interest rate will be “locked in” for five years. After that, the rate will adjust based on some type of index (what that index is will vary from bank to bank or loan to loan). An interest only loan still has a duration (I think it’s almost always 30 years) at the end of which it must be paid off. You could pay extra every month, or only pay interest for 358 months, then cut the bank a check for $475,000 at the end (ok, that might be extreme, I haven’t actually seen an interest-only contract, so there may be additional limitations).
Here’s a couple hypothetical numbers that I got from an online mortgage calculator. I think that IO loans typically have slightly lower interest rates, so let’s say your choices are a 6.9% fixed and a 6.5% IO.
[ul]
[li]6.9% Fixed: monthly payment of $3128.35, around $400 goes to principal each month (with the amount increasing as the principal is paid down), after 5 years the remaining loan balance is $446,643, giving you $28,357 in equity[/li][li]6.9% IO: monthly payment of $2,731.25, nothing goes to principal, after 5 years the remaining loan balance is still $475,000.[/li][li]6.5% IO: monthly payment of $2,572.92. If you paid the $3128.35 per month you would’ve been paying with the 6.9% fixed, after 5 years your balance will be around $435,745.10, giving you $39,254.90 in equity. {note: due to differences in interest calculations with IO vs. fixed, this is likely inaccurate. I used a fixed rate calculator with 6.5% rate and extra payment bringing total monthly to $3,128.35. You’ll probably actually have more equity than that}[/li][/ul]
IMO, the key to playing the interest only game is what you do with that extra $400 / $550 a month that you’re not required to pay to the mortgage company.
[ul]
[li]If you need it to pay for necessities (not counting the mortgage itself), then you’re likely getting into a house that’s over your budget. A downturn in the housing market, an increase in interest rates (or worse: both) could potentially put you into some serious hurt. Being upside down on a mortgage (owing more to the bank than the property is worth) is not something you want to get into.[/li][li]Dumping the extra money into the mortgage might be a good plan if the interest-only has a lower rate than the fixed (as shown by the extra equity in the third bullet above). But once you get past the lock-in period, your rate is at the whims of the market. There are limits placed on the bank about what indexes can be used, how much they can change the rate, and how often, so you do have some protection from wild variations. [/li][li]Investing the money. If you’re good with managing your money, this might actually work. Even a simple money market account (at my bank I can get one at 2.2%) will net you roughly $35,000 (that was an after-tax calculation, so it’ll depend on your tax bracket) with a $550 monthly deposit for five years. With other investment options (CDs, bonds, mutual funds, playing the stock market) it may be possible to grow that money faster than a fixed rate mortgage would’ve been paid down. Again, once you get past the lock-in period, the mortgage payment will change, and there’s the risk of investment (which will vary depending on what investment option you use).[/li][/ul]
Note: I am not a mortgage broker, realtor, banker, or financial advisor. I just like to play with numbers, and went through a similar evaluation for myself last year. Given my budget, risk comfort, guesses on future interest rates, and time I expect to keep this house, I went with a 30 year fixed.
sigh. And after all that, I re-read through the previous posts again and realized I’ve basically duplicated what Mama Zappa wrote.