Interest-Only Loans Can Buy More House and More Trouble
They?re spreading like wildfire?interest-only mortgages seem to be the panacea for rising home values and the incomes that cant quite get caught up. You can buy ?more house? and have a low mortgage payment and a big tax deduction. Who wouldnt want one, right
Well, a large number of consumers are getting into these loans when they shouldnt. 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 glance at San Diego. In nearly half of the mortgages required interest-only payments in the first few years according to a study done by LoanPerformance, a San Francisco?based property information service. Could this have something related to the housing market Without a doubt 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 industry 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 part 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 for that reason aren?t as likely to get in as much trouble with such a loan.
Today, interest-only loans are being utilized by borrowers who?re trying to leverage debt. What they are doing is getting more debt for their buck; they?re borrowing more income but keeping their debts low (initially) in order to compete with other buyers in sellers markets. Here are some of the potential dangers that face such borrowers:
When the principal balance isn?t being reduced, than no equity has been built, and if home prices are stagnant during the interest-only period and the borrower must 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 incorporated in the borrowers control, appreciation isn?t.
If theres a downturn home based prices, the borrower will finish up upside down, meaning the mortgage balance about the property could end up being greater than the propertys market value. In this case, the borrower could be responsible for sales costs and also the remaining mortgage balance that could lead to foreclosure.
Interest-only mortgages make sense for borrowers:
who have seasonal incomes or earn commissions and/or bonuses this will let you desire to pay on the principal when its convenient.
upwardly mobile those who expect to earn more in a few years and want to buy more house in early stages rather than later.
who anticipate investing their cash flow in higher yielding investments or reducing high-priced debt.
Make sure guess what happens youre getting into with an interest-only loan. Talk to your mortgage broker or lender to be aware what the possible repercussions could be, and be sure youre getting the loan for the best reasons. Eventually, you need to own your home, and its easier to be planning on that earlier than later.
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