Loan Features To Avoid: Interest-Only Loans
Welcome to one of the most controversial areas of mortgage lending these days. These loans are the scary spawn of the boom in housing prices and they are being pushed hard by mortgage lenders. Many borrowers unfortunately don’t understand the risks that loom down the road when they must start paying back the principal or refinance to another mortgage. An interest-only loan is usually an ARM or hybrid mortgage that allows you to pay only interest during the first few years. Five years is the typical interest-only payment period. After that for the remaining twenty-five years (this is on a 30-year loan) you repay interest and principal. Sounds good and tempting doesn’t it?
Unfortunately, even if interest rates remain steady, your payment will jump sharply after the interest-only period. That’s because you delayed paying any principal. If you’ve been making interest only payments for five years for instance, you have to pay off the entire amount you borrowed in twenty-five years instead of thirty. If interest rates rise, you’re in for an even bigger payment stock. You are taking a lot of risk in this type of mortgage. During those interest-only years, the only equity you build up will come from your down payment and any appreciation in local real estate values. While price increases have been very strong in recent years you always must be prepared for the idea that real estate prices could lose steam at any time. If you needed to sell the home unexpectedly, would you get enough from the sale, after paying off the big mortgage, to cover the real estate broker’s commission or would you have to bring cash to the closing table? These loans can be a reasonable choice for the financially sophisticated investor, in other words the investor who already is sitting on a pot of money that they could tap should times get tough. Those savvy souls may indeed take the savings from their interest-only payments and invest them in other assets and barely bat an eyelash when the interest-only option expires. But if you like to keep things more straightforward when talking about financing the roof over your head then you should want your loan payments to actually pay off the loan.
These interest-only loans are not being pitched solely to the Donal Trumps of the world – unfortunately. They are actually being sold and sold hard to homebuyers who are stretching their dollars to the snapping point in order to buy homes in outrageously expensive markets. Do not even consider one of these loans unless you have a plan to deal with the payment jolt at the end of the interest-only period and do not let any loan officer get away with implying that you’re unsophisticated if you recoil from the risk. You are just simply being wise with your hard-earned money.
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Comment by interestonlymortgage :: June 29, 2010