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Interest-only Loans Can Buy More House And More Trouble
By: Brian Daniel
They're spreading like wildfire--interest-only mortgages appear to be the
panacea for rising home prices and the incomes that can’t quite catch up. You
can buy "more house" and have a low mortgage payment and a big tax deduction.
Who wouldn’t want one, right?
Well, a large number of consumers are getting into these loans when they
shouldn’t. Interest-only mortgages work well for some individuals and are
dangerous for most others, yet the number of interest-only loans is rising
rapidly.
Take a look at San Diego. In 2004 almost half of the mortgages required
interest-only payments in the first few years according to a study done by
LoanPerformance, a San Francisco--based real estate information service. Could
this have something to do with the housing market? You bet it does. Are home
prices rising faster than salaries and incomes? They sure are. So how is one
supposed to afford a house in such an expensive housing market? You guessed
it--an interest-only loan.
Interest only-loans were originally aimed at more sophisticated investors who
wanted to leverage their income by re-directing what would have been the
principal portion of their payment to higher yielding investments that exceed
the rate of their home appreciation. These types of investors typically have
more assets and financial discipline than most and therefore aren't as likely to
get in as much trouble with such a loan.
Today, interest-only loans are being utilized by borrowers who are trying to
leverage debt. What they are doing is getting more debt for their buck; they're
borrowing more money but keeping their payments low (initially) in order to
compete with other buyers in sellers’ markets. Here are some of the potential
dangers that face such borrowers:
• If the principal balance isn't being reduced, than no equity is being built,
and if home prices are stagnant during the interest-only period and the borrower
needs to sell, he'll need to be able to pay sales costs out of whatever equity
there is in the house, if there is any. Remember, mortgage amortization is in
the borrower’s control, appreciation is not.
• If there’s a downturn in home prices, the borrower could end up “upside down,”
meaning the mortgage balance on the property could end up being greater than the
property’s market value. In this case, the borrower would be responsible for
sales costs and the remaining mortgage balance which could lead to foreclosure.
Interest-only mortgages make sense for borrowers:
• who have seasonal incomes or earn commissions and/or bonuses and have a desire
to pay on the principal when it’s convenient.
• upwardly mobile individuals who expect to earn more in a few years and want to
buy “more house” early on rather than later.
• who intend on investing their cash flow in higher yielding investments or
paying down high-priced debt.
Make sure you know what you’re getting into with an interest-only loan. Consult
with your mortgage broker or lender to know what the possible repercussions
could be, and be sure you’re getting the loan for the right reasons. Eventually,
you want to own your home, and it’s better to be planning on that sooner than
later.
About the Author:
Brian Daniel is a loan officer for http://www.bendmortgagegroup.com, a mortgage company in Bend, Oregon. He is also the company's marketing coordinator. For more articles visit http://www.bendmortgagegroup.com/Articles.
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