The Return of Interest-Only Mortgage Home Loans
The growing number of interest-only mortgage home loans that are being advertised on the market reminds one of a pit bull: they can either be a wonderful asset to the owner or they can tear everyone in the house apart — no one really knows.
Interest-only loans were a key part of the destroyer financial machine that provoked the burst of the real estate bubble in 2006–7. These low-payment, high-risk loans were peddled to all sorts of people who could not qualify for a standard mortgage home loan. Millions of those new homeowners have now had their homes foreclosed and millions more are upside-down on their loans.
Why have interest-only mortgage home loans returned? Because interest rates have remained low and lenders are banking on good-credit clients being interested in the very low monthly payments offered.
How low are the payments? For the sake of argument in an ever-changing market, let’s say that a current 30-year fixed rate, fully amortized loan has a loan amount of $350,000 and an interest rate of 4.5%. The loan would have a mortgage payment of approximately $1,775.
Now, if that same loan carried an interest only payment, the monthly payment would drop to approximately $1,313: saving the homeowner over $450 a month. That savings can be quite appealing, but aside from the interest rate deduction on your federal tax return, you are making no progress towards homeownership and are essentially still just renting!
Analysts are telling us that there is no need to fear a second mortgage crisis as interest-only loans are again being peddled. They say that only people with high credit scores are being pitched to this time. In other words, the pit bull has been tamed after a few years of involvement in dog fighting.
If you are someone who loves a good deal, has a sterling credit report and is interested in purchasing a huge home for a low monthly payment, perhaps you have been tempted by a low-interest-only mortgage home loan in recent days, either through a mailing, a website ad or even a conversation with a banker. Before you convince yourself that the dog has been reformed, be aware of these risks:
• Lenders are widening the scope of their advertising to include people who can only make a 20% down payment on a given home as they try to sell interest-only mortgage home loans. Be aware that these lenders have homes that they want to rid themselves of, so they have a strong motivation to craft the terms of a mortgage home loan to get more consumers to bite. A few years ago, only people who could put down 40% on a home were offered interest-only loans; now, that has been halved. Beware.
• If interest rates rise to the average rate over the past half-century, then your payments on an interest-only mortgage home loan will balloon, probably beyond your means. The average mortgage rate over the past 50 years has been 7–8%. Even a jump to 6% in the next few years will necessitate a refinancing on your part, in all likelihood, to a conventional fixed rate mortgage. Do you want to see the math? Your $1,700 monthly payment could become a $3,600 monthly payment. Yikes! The pit bull has broken out of his cage!
• Don’t let your ability to save for a large down payment fool you into thinking that you are a financial genius. It simply means that you were very disciplined, which is a definite positive. Be slow to plow that pile of cash into a risky bet on America’s housing future.
Thankfully, to this point, most of the takers on interest-only mortgage home loans have been investors as they snap up homes, particularly in California. Yet, as the required down payment for interest-only loans continues to sink, beware of this pit-bull-of-a-deal. If interest rates stay historically low, you do indeed have a super-low monthly payment with the ability to put a dent into the principal.