Interest only loans, Pros and Cons

Interest only mortgage loans have become a practical tool in more instances than originally thought. Especially with the new brand of Fannie Mae Interest First products coming into play. In this article we will examine the good, bad and ugly facts about interest only mortgages, and let you decide.

Interest only mortgages are exactly what they say they are, interest only mortgage loans. This means you will pay ONLY the interest as opposed to the principal in your payments For Example:

100k mortgage at 6% yields you a payment of $599.55 fully amortized over thirty years. An interest only Payment is $500 yielding you a $99 per month savings, or does it? If you make interest only payments for 10 years guess what you owe on your home in ten years? Yup 100k.

Interest only mortgage loans are pay me now or pay me later mortgages. Taking our earlier example you can save $99 per month in monthly payment (pay me now) or $99 per month into the equity savings account attached to your home (pay me later). The $99 dollars is realized as a savings to both borrowers in one form or another. This being true, then the debate is really which borrowers will benefit from which loan the most. This depends on many factors such as age, goals, income and life style.

I had a borrower that did an interest only mortgage loan this year. She was buying a town home for 145k. She was a first year elementary teacher making 27k per year. She is single and working on her masters degree with hopes of teaching at a University eventually. Her interest only payment was $755 and her 30 year fixed PITI payment was $892. Her goals were to finish her masters in 2 or 3 years and move to Athens to teach at UGA.

I advised the interest only mortgage for these reasons; She needed the extra $137 per month to buy groceries, she did not intend to pay the home off and appreciation in that area of town was running at 5% per year on average. She would realize a profit when she sold her home regardless of whether she ever paid a nickel of principal. Pay me now or pay me later.

Conversely, same complex 148k selling price. I had a borrower age 46 just divorced and relatively broke. He works at the local GM plant and has been there 18 years. His goals were to stay in this home and retire there. We put him on a thirty year fixed mortgage for obvious reasons. Recommending an interest only mortgage would not be in the best interest of my client.

However their are a lot of “Loan Officers” (I use the term loosely) that take the easy sell, the lower payment. It is easy to sell a lower payment to someone paying child support and with little savings, but is it wise? This is the real crux of the interest only mortgage loans debate, professional loan officers recommending the best products and willing to lose a deal over principal. In this era of “lenders competing” many borrowers will equate their best deal with the lowest payment, and this simply is not the case.

My suggestion to most borrowers I speak with is to really examine yourself. Where will you be in 5 years. Married with kids, divorced and broke or upwardly mobile? Is your income likely to go up over the next ten years ar will you begin to see it decline maybe even to a fixed income? Interest only loans are great tools for second homes or first time buyers on a strained budget. Most first time home buyers stay in a mortgage 3.5 years. They are not so great for people who will retire in 10 years or sooner, or in areas that property values rarely rise over 3% a year.

To sum up Interest Only mortgages:

The “Pros”

• Lower Payments
• Build Equity without paying principal
• Great short-term housing product
• Great way to qualify for younger borrowers
• Can be on thirty year fixed products now
• Same tax deductibility as regular mortgages

The “Cons”

• Poor product for borrowers showing poor fiscal responsibility
• Can be easily sold to unwise borrowers by poor loan officers
• Pays nothing toward principal
• Could be bad for borrower should property values drop
• Most people go into these products with the intention of paying principal on the side and never do.

The facts are, know yourself, your goals and how you pay your bills. If you squeak by each month, rarely save and intend to be in the home more than a few years I suggest a traditional mortgage.

Tags: interest only mortgage loan, interest only mortgage loans, interest only mortgages, Mortgage Basics, Mortgage Tips

This entry was posted on: Saturday, March 15th, 2008
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