Main Menu
Contact Us
News Feeds
Financial News
Real Estate News
Home arrow Real Estate News arrow General News arrow Handling interest-only loan to free up cash or buy more house
Handling interest-only loan to free up cash or buy more house Print E-mail
Sunday, 27 August 2006

An interest-only mortgage can significantly lower monthly payment or allow to buy lot more house.  Whether these loans turn out to be a blessing or a curse, though, depends a lot on who's doing the borrowing. 

This can work with disciplined investors, good with money and a risk-taker. 

Most mortgages require that you pay back some principal with each payment -- a little bit at first, a lot more as time passes. Interest-only loans skip that requirement in the early years of the loan so that none of your payment goes toward paying down principal. The result is a significantly smaller initial payment compared with other options, such as a 30-year fixed-rate mortgage or a hybrid loan whose rate is fixed for the first five years:

Interest-only loans come in many different forms.  The rate adjusts before becoming variable. The interest-only portion may end after the fixed period, or it may continue for a few more years before principal payments are required.
Here's how it might work for a five-year, interest-only loan:

Your payments would be fixed for the first five years at a certain interest rate -- say, 3.875%.

For the next five years, you still might pay just interest on the loan, but the rate would be variable and could increase by two percentage points every six months, up to a cap of 9.875%.

In the 11th year, the rate remains variable, but the loan requires you make both principal and interest payments.

Nobody can accurately predict future interest rates. But this is an example of what you might pay on a $500,000 mortgage if the rate started at 3.875% and jumped three percentage points in the sixth and eighth years.

And interest-only loans aren't really meant for the long haul. Lenders say most borrowers who get them expect to either sell their homes or refinance before the interest-only period ends.

As you can see, the monthly cost can climb steeply, especially once you start paying back principal. You could end up paying a lot more each month than if you had stuck with a 30-year, fixed-rate loan.  Interest-only loans make the most sense when you're borrowing a big chunk of money. At smaller loan amounts, the savings might not offset the loans' greater risk.

Opting for an interest-only loan now means you're passing up the chance to lock in today's low interest rates. If you wind up owning the home a long time -- say 10 years or more -- you may wish you had opted for that fixed-rate loan.

In the past few years, however, spiking real estate prices -- and increasingly risk-tolerant borrowers -- helped spark a revival for mass-marketed interest-only loans. Wells Fargo introduced its version three years ago, followed by E-Loan and other major lenders. Interest-only loans currently make up about half of the adjustable-rate mortgages that E-Loan brokers, or just under one in six loans the online lender makes overall; other lenders report similar surges in interest.

Interest-only borrowers come in two basic types:

The upwardly mobile. These people are stretching to buy more house, since the same payment on an interest-only mortgage will buy about 20% more house. Translated, that means someone who could qualify for a $500,000 house on a traditional 30-year fixed-rate mortgage might be able to land a $600,000 place with an interest-only loan. Many of these folks expect their incomes to rise sharply in a few years, and they want a bigger home now, rather than waiting to trade up.

The cash-flow crowd. Others want the smaller payment, for whatever reason. They could be investing the difference, or they might be business owners or commissioned salespeople with irregular incomes, said Washington Mutual executive Lenny McNeill. These borrowers want a smaller payment for the lean months, while being able to pay down their principal in big chunks when the money comes in.

The interest-only solution can work for awhile, but eventually most Americans will want to own their own homes -- not just rent them from the bank.


< Prev   Next >