The Truth About Interest-Only Loans
Posted by David Rosenfeld on Jun 1, 2013 - 5:42:43 AM
LOS ANGELES—Many borrowers are seeing lower monthly payments and lower interest rates these days thanks to the growing popularity of interest-only loans.
Interest only loans can be misleading.
It’s not a new phenomenon exactly, but the popularity of these loans is giving many a chance at monthly payments 30 to 40 percent lower than a conventional home loan. It sounds like a great deal but it’s exactly the same type of loan that brought many to foreclosure at the height of the recession. According to Corelogic, a real estate analytics company, interest-only loans made up 14 percent of private mortgages last year.
Today, interest-only jumbo loans have grown by 50 percent through March compared to a year earlier, says a report by the Bank of New York Mellon. It’s food for thought, as they say. It’s all because these loans permit interest-only payments for the first 10 years which appeals to buyers who want to sell their homes during that time and avoid paying the principal toward the loan.
Many wealthy buyers are taking advantage of these loans because of the flexible payment options they provide. For instance borrowers can pay the principal without having to worry about a penalty for doing so for the most part.
It’s especially attractive to affluent buyers who are self-employed or own a business and who don’t have to worry about the fluctuations of their income during the year. It seems like a good deal until you examine things closely and find that proverbial pebble in the shoe.
Interest-only loans are especially risky and a reminder of what went wrong during the recession when many borrowers ended up losing their homes. Likewise these loans make it difficult for borrowers to build equity and should home prices drop, they may find themselves owing more than the home is worth.
Some mortgage companies require more money for a down payment, which can mean 30 percent or perhaps more, depending on the company. Other lenders may charge higher rates as well as part of their adjustable rates. This can in turn mean that your regular monthly payment can grow higher than you may expect, so be prepared to pay more down the line.
It’s easy to think that an interest-only loan could be worthwhile, but in this post-recession world, it’s best to be safe than sorry. Don’t take chances with your future and your investment. I’ve always said I’m a big fan of FHA loans because the benefits of these government-backed loans surpass anything else out there.
You don’t need to have perfect credit or a lot of money in the bank for a down payment. The typical FHA loan generally requires a 3.5 percent down payment, instead of the 20 percent required by most lenders. Under FHA rules, those paying less than 20 percent down payment and over 15-year amortization are required to pay mortgage insurance premium every month as part of the monthly payment.
But it’s still a great deal for borrowers. To me, it’s a gift from the government because they’re taking all the risk and in turn it’s almost zero risk to you and you’re getting your own home for a fraction of what you would have had to put as a down payment.
So talk to your real estate agent about financing and your other needs before you make a decision about your mortgage options.
David Rosenfeld is a Real Estate broker and president of Advantage Real Estate, a Real Estate and investment firm in Santa Monica, and a Rotary Club member. He has more than 20 years experience in commercial and residential property investments and financial counseling. He can be reached at 310 450-4488, at firstname.lastname@example.org at www.advantage-realestate.com.