Interest-Only Mortgages in a Fixed-Rate Economy
It used to be that when you wanted to buy a house you saved up enough to
put a 20% down payment on a home that suited your families needs and then made
monthly payments for the next 15 to 30 years. Now, however, that is hardly the
norm. With more and more types of mortgages being offered there is one to suit
virtually any need and any financial situation.
A recent survey conducted found that nearly 25% of all home loans are of
the new, un-conventional loan types, with nearly two-thirds of those being
interest-only loans.
In an interest-only loan, the borrower will typically only pay the interest
on the borrowed principle for the first 3, 5 or 10 years at which time the
loan converts to a fixed or
variable rate loan and the borrower
now has to begin paying back the principle as well as the interest.
This type of loan is great for those that only plan on living in the house
during the first few years, when the mortgage payments are low. If they are
able to sell their home before the loan converts and their payments increase
by up to 50% more, and if the housing market continues to rise as they have
been and they build up equity, they will be able to get out of their home and
make a tidy profit as well.
However, if the buyer plans on living in the home for a while they may be
in trouble when they have to begin paying the principle back on their loan. As
mentioned before, their payments may go up as much as 50%! If they have been
paying $1000 a month on a interest-only payment they may now have to
come up with an extra $500 to start paying down the principle.
Some other things that interest-only buyers have to watch out for:
Buying too much home - Many buyers think that since the payments are
lower, that they can now afford a bigger, better home. However, many buyers
are mourning the day when the low payments end and the bigger, better mortgage
payments start. Many borrowers are finding themselves unable to make the new,
inflated monthly payments and are having to foreclose on their beautiful
homes, losing their dignity and credit in the process.
Rising Interest Rates - The majority of interest-only loans today
will convert to variable interest rate
loans. Meaning, that by the time the loan converts, you may be paying much
more than the 6% interest that we see today. The difference between a
locked-in 6% payment on $200,000 and a adjustable 10% mortgage payment on the
same amount is a staggering $556 a month!
Deflating Housing Prices - With many home buyers thinking that they
can simply sell their home and move to another when their mortgage comes time
to convert, some may be in for a shock. Several experts are predicting a
bursting of our housing bubble and the decline in some of the more inflated
housing markets. If you are caught trying to sell your interest-only home
after the bubble bursts you may have to come up with several thousand dollars
to pay back your loan after your home sells for less than you paid for it.
No or Low Down-Payments - Part of the enticement to interest-only
loans are the low, or even non-existing down payments. People that have never
been able to save a penny are now able to get into the home of their dreams.
However, keep in mind, the more you borrow, the more you have to pay back...
with INTEREST!
Expecting an Increase in Wages - Often borrowers will take on an
interest-only loan with the expectations of wage increases to cover the
inflated payments that are coming down the road. While we certainly do expect
to increase earnings as we get older, wiser, and more experienced it is a
gamble to borrow against uncertainty. If you are in this group, I hope that
you are right, because you are betting your house on your expectations!
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