Interest-only loans gaining popularity
Taking out a mortgage will probably be the biggest financial investment you make in your life. Naturally, the ideal situation is to have a large down payment and make hefty monthly payments so that you do not have to borrow as much money and so that you can eliminate extra fees.
Luckily, there is a way to get a mortgage to cover the cost of the majority of homes, without having to make such a large down payment and without having to stretch your financial budget thin each month.
Lew Sichelman’s article, “Demand Up for Interest-Only Loans,” which can be found on move.com, explains how interest-only loans provide this option for the majority of borrowers that want to own a home now, without having the immediate cash flow.
As with every loan, especially one as large as a mortgage, you must carefully understand what you are getting yourself into before signing everything.
Interest-only loans are one of a variety of “exotic” mortgages which means that they are non-traditional and are meant to help a select group of people. These loans are not meant for everyone.
“Picking between the various mortgage products is a lot like choosing between butter and margarine, according to the new survey from the Mortgage Bankers Association which confirms the increased popularity of such nontraditional products as interest-only and pay-option loans.”
According to the article, when cash flow becomes tight, the majority of people switch to the low-end spread of butter or margarine. Oddly enough, this analogy carries over to the mortgage and finance world. As money gets tight, more people are switching to “exotic” mortgages, such as interest-only options, in hopes of saving on their monthly payments.
“Like the name implies, interest-only mortgages are loans in which borrowers make interest-only payments for a set period, usually three, five or even 10 years, and then make regular payments over the remaining term. In choosing an IO, many consumers are forgoing a gradual, albeit slow build-up in equity in hopes that home values will continue to appreciate rapidly.”
“ The IO is the affordable loan product du jour, said Doug Duncan, the MBA's chief economist. ‘It is enjoying overall market acceptance because it offers the lowest payment alternative that gets people into the house they want to buy,’ he said.”
According to a survey conducted by the Mortgage Brokers Association, adjustable rate mortgage (traditional mortgages) originations fell from 46 percent to 36 percent from the last half of 2004 to the first half of 2005, while interest-only mortgage originations grew from 17 percent to 23 percent during the same time period.
But interest-only mortgages do have risks. “In the case of IOs, the danger is that prices won't go up as fast as they have been, that they won't go up at all, or, heaven forbid, that they could fall. With any of these scenarios, an owner could find that he's built so little equity in his house that he'll take a loss when it comes to sell.”
While saving money for the first few years of the loan when you are paying only the interest, you will not be paying anything towards your principal balance, which means that when the interest-only option is done, your monthly payments will increase and your loan term will probably last at least five years longer.
Basically, interest-only mortgage loans are perfect for people who have less than ideal income but want a house right now. They can make low monthly payments for a specific amount of time, but must keep in mind that their payments are going to increase in the future.
If you have the proper finances to buy a house, do not use an interest-only mortgage. A traditional mortgage will save you a lot more money in the long run.