Interest Only Mortgage

[Noirish]

I can see two senarios where having an interest only mortgage are good.

1. You are confident that you'll be making a lot more after 5 years. A combination of deflation and raise can make the increased payment affordable.
2. You are sure, your house will appreciate at least 10% a year over the next 5 years. You'll sell your house before the 5th year (assuming there is no penalty). With whatever money you made, you can afford (wouldn't other houses appreciate as well :roll another houses at that time...

I guess only #1 is good.

 

[Vic]

I'm not in favor of first-time homebuyers getting interest-only mortgages. And I find it odd that we're not seeing actual real hard numbers here, like rate and payment comparisons. That's how you compare mortgages, you know, with real hard number crunching and real figures. Not imaginary situations as presented by cheesy salesmen (is the historical appreciation rate for homes in Phoenix in excess of 10%?)

The reason to own your home is to build wealth. Not to get a tax deduction and not to hope for magical dot-com-boom style appreciation numbers (although those are great perks). You have to live somewhere, so the object is to lock in your housing expense for the long-term with the goal of eventually not having a housing expense at all because you paid it off (of course, by then though the property taxes will be higher than your original mortgage payment... true story in my mother's case).

When you take out an ARM, you absorb a good deal of the lender's financial risk. Of course for that they reward you with a rate that is lower than comparable fixed rate mortgages that are available at the same time. And in an environment where rates have been coming down steadily for the last 20 years, ARMs have been a very good deal for many. This is because when rates are high and look to be lower in the future, one should most certainly get an ARM. But when rates are low and look to be higher in the future, as the environment is now, get a goddamned fixed. Or better yet, if you really truly plan to move in 5 years, get a conventional 5/1 ARM.
If you're only borrowing $100k, the P&I is less than $600/mo. for any conforming 30 fixed today.

 

[Vic]

Originally posted by: 1cito
whats to stop someone from taking the interest only loan (for the lower interest rate) and then just making the extra payments. isn't this a better way to lock in a lower interest rate?

Because if you plan on paying principal, there are other and better ARM products out there that offer a lower interest rate than just an interest only program. The best IMO is a conventional Fannie Mae 5/1 ARM. Get a rate in the 4's today.

And if he's just meeting his loan officer to take an application and go over the initial disclosures, he can sign papers until he's blue in the face and it doesn't commit him at all.

Rob, how come your Wells Fargo Home Mortgage link redirects me to paypal.com?

Interest-only loans, btw, were created for investment (rental) property owners, where someone else is making their payment for them, and cashflow maximizing is crucial.

 

[Thegonagle]

Good post, Vic.

The first time I heard of the interest-only mortgage, I was listening to a radio commercial while I was driving. The red flag went up so fast, I nearly crashed my car.

 

[dirtboy]

Assuming your house will appreciate at 10% a year for the next 5 years you're probably okay. While I'm not familiar with the housing market in your area, the coming of rising interest rates is going to put the brakes on the housing market. What we'll see is people not moving for more than 5 years, because the predition is that the market will only rise at about 2% annually in the coming years.

Like anything, an interest only loan is a risk that only you can decide to take. Just make sure you have money to refi in 5 years or that you can afford the 25 year ammortized loan, in case you're forced to stay there.

 

[Banana]

Our good friends bought their home 2 years ago for $160K, and just sold it for $230K. That's a $70K profit in 2 years.

But if they are buying again in the same market, they also have to pay more. The $70K 'profit' would be apparent only if they buy in a cheaper market.

 

[Rob9874]

Originally posted by: Vic
I'm not in favor of first-time homebuyers getting interest-only mortgages. And I find it odd that we're not seeing actual real hard numbers here, like rate and payment comparisons. That's how you compare mortgages, you know, with real hard number crunching and real figures. Not imaginary situations as presented by cheesy salesmen (is the historical appreciation rate for homes in Phoenix in excess of 10%?)

No, home appreciation more like 6.5% for Chandler/Gilbert. But the appreciation on money put in home equity is 0%. We're looking to pay around $200,000, which would equate to $13K/yr in appreciation. If appreciation rates stay the same, we're talking $65K in 4 years. And that number is conservative, compared to some actual appreciation figures we've seen.

The reason to own your home is to build wealth.

I agree with this, but disagree that the wealth is built by pumping equity into your home. Money put towards home equity grows at a rate of exactly 0% per year. If you make $65K in home appreciation in 5 years, make nothing in 5 years, or lose $65K in 5 years, none if it has anything to do with how much equity you have in the home. The only reason to put equity into your home, IMO, is if your goal is to pay it off and not have a house payment. But in this scenario, we're talking about someone who will be moving in 5 years. No "what if's". Purely hypothetical situation, in which the owner is guaranteed to move before 5 years. What benefit is there in having home equity vs. putting that money into a savings account?

OK, here's some real numbers. In a $200K home, 60 payments is around $64K. With $16K going to equity, and $48K going to interest. If I only pay on the interest ($48K/60), my payment is around $800/mo, instead of $1074 if I were paying towards principle. Instead, I have $274/mo to save, pay off high-interest debt, or put towards principle if I choose. If I save it, at the end of 60 months, I have $16K cash. No different than $16K equity, right?

And no, I'm not signing anything tonight. Just starting the documentation/application process, and listening to our options. This is fun!

 

[flot]

A few things:

1) You might find that, in 5 years, you want/need to stay in the house.

2) You might realize that the house is a good long term investment, and want to keep it (and rent it out)

3) Interest rates are at ridiculous lows. Only with a conventional mortgage will you be able to lock in that rate for such a long period of time.

4) Penalties. Watch out for them. Check the fine print a few times.

My ex-gf helped me get my mortgage (by which I mean, she worked for the bank I did it through) and she walked me through all of that stuff. Her basic rationale was "the bank is going to make their money either way... so get the loan that is safest for you" which for me was a 30 yr fixed. The ARM products they had did carry some penalties you had to pay if you paid them off or refinanced before a certain amount of time. And the interest only loans were tempting, but again, if I changed my mind and decided I wanted to keep the place long term - they would have been a poor choice.

I've lived in the house a little over a year now and it has probably appreciated ~$15,000-$20,000. My mortgage payments aren't cheap, but they are survivable. If I had to do it all over again and buy ANOTHER house, I probably could - and keep this one. Then, in 30-35 years, I'll own two houses - which is a nice situation to be in. Plus I'm guessing that within 5-10 years, I should be able to rent out my house for at least what the mortgage payment is - also a very good position to be in.

Edit: PS: I have a $200k home. My total monthly payment including principle&interest, taxes, and insurance is just under $1500. Yours will likely be a tad lower depending on where you live (and the costs of insurance and taxes) however DON'T be fooled by the mortgage calculators - your monthly payment WILL be substantially higher than just the loan itself. (and yes I think my P&I payment is around $900-950 (?) of that $1500)

 

[spidey07]

again, you're making the "assumption" that your house will appreciate at that rate.

location, location, location.

 

[Rob9874]

Originally posted by: Vic
Rob, how come your Wells Fargo Home Mortgage link redirects me to paypal.com?

It shouldn't. It's putting an extra http in front of the https. I tried editing it, but it keeps adding it. I should have linked as an https. Mine shows an error page. Not sure why you get paypal. Copy/paste the URL into your browser.

 

[dirtboy]

Originally posted by: Rob9874
I hear what you're saying, but the Phoenix home market hasn't seen a decline in years (would have to research the data). Homes are popping up so fast here, that most secondary market homes sell within days, for full asking price.

The same seems to be true everywhere right now. Anyone who sells is getting what they offer. New homes are going up everywhere. People are specing on the market, making money and are suddenly real estate experts. Sure reminds me of the run up in the stock market a few years back.

If you're going to do this, just be careful and keep a contingency plan in place. Lots of people lost their arse in the stock market and people specing on houses right now have the potential to lose their arse when rates start going up. Don't be one of those people, because I don't want to see you posting here 5 years from now seeking advice because you're going to lose your house.

 

[Rob9874]

Originally posted by: dirtboy

Originally posted by: Rob9874
I hear what you're saying, but the Phoenix home market hasn't seen a decline in years (would have to research the data). Homes are popping up so fast here, that most secondary market homes sell within days, for full asking price.

The same seems to be true everywhere right now. Anyone who sells is getting what they offer. New homes are going up everywhere. People are specing on the market, making money and are suddenly real estate experts. Sure reminds me of the run up in the stock market a few years back.

If you're going to do this, just be careful and keep a contingency plan in place. Lots of people lost their arse in the stock market and people specing on houses right now have the potential to lose their arse when rates start going up. Don't be one of those people, because I don't want to see you posting here 5 years from now seeking advice because you're going to lose your house.

But the $16K in equity that I'd be forfeiting isn't going to save me. Especially if I put that money into savings/investment. I don't hear anyone acknowledging that if the housing market tanks, the little amount of equity that you have contributed isn't going to mean squat. All it takes is an 8% decline in home values, and the equity you built over 5 years is gone anyway. I'd rather invest that money. What good is it to sit in your house making 0%?

 

[Rob9874]

Phoenix Home Prices Should Remain Stable

 

[spidey07]

Originally posted by: Rob9874

Originally posted by: dirtboy

Originally posted by: Rob9874
I hear what you're saying, but the Phoenix home market hasn't seen a decline in years (would have to research the data). Homes are popping up so fast here, that most secondary market homes sell within days, for full asking price.

The same seems to be true everywhere right now. Anyone who sells is getting what they offer. New homes are going up everywhere. People are specing on the market, making money and are suddenly real estate experts. Sure reminds me of the run up in the stock market a few years back.

If you're going to do this, just be careful and keep a contingency plan in place. Lots of people lost their arse in the stock market and people specing on houses right now have the potential to lose their arse when rates start going up. Don't be one of those people, because I don't want to see you posting here 5 years from now seeking advice because you're going to lose your house.

But the $16K in equity that I'd be forfeiting isn't going to save me. Especially if I put that money into savings/investment. I don't hear anyone acknowledging that if the housing market tanks, the little amount of equity that you have contributed isn't going to mean squat. All it takes is an 8% decline in home values, and the equity you built over 5 years is gone anyway. I'd rather invest that money. What good is it to sit in your house making 0%?

you are still assuming too much. You are assuming you will make money in the market and you are assuming your house will appreciate.

Trust me...crunch the numbers. Its not as clear cut as you're making it out to be.

 

[spidey07]

Originally posted by: Rob9874
Phoenix Home Prices Should Remain Stable

guess you didn't read this paragraph...

"However, there are a few issues to look out for. These include rising vacancy rates, which are close to 15% and could point to a slowing in home-price appreciation. Permits for new single- and multi-family units are also approaching 20-year highs. If the rapid rate of building continues, it could outpace demand and lead to an oversupply of housing.

Overall in the Phoenix market, the positives still outweigh negative factors. Home prices in Phoenix should continue to rise this year, but not at the pace of previous years.
"

 

[3chordcharlie]

Many people managed to lose their homes due to the high interest rates of the early 90s, even without being on interest-only plans.

If you are on interest-only, that also means you are making the absolute minimum payment - there is no room for flexibility when rates go up.

It's a high-risk plan that allows you to borrow money from yourself @ whatever your mortgage rate is. So you have to significantly beat the mortgage rate when you invest the balance of what you should be paying down for it to be worthwhile. Increases in the value of the house are irrelevent to the argument, because you benefit from those either way. If the house value decreases to the point that you owe close to or more than 100% of the value of the house, your bank will get very sketchy when you go to renew the mortgage though.

 

[alkemyst]

first thing that the two scenarios are likely to be a lot different if both are amoritized. Just go on that, screw what it may be worth.

Figure purchase, closing costs (different loan products can vary greatly), points, P&I payments, mortgage insurance payments, and then do the sums. See what the final balances are and what you have paid out of pocket in total. The scenario you show is the typical mortgage guy over simplifying things.

next you must verify prepayment penalty on any short loan.

Finally it's an inflated house market now, chances are over the next 5 years you are not going to see big gains...possibilly depending on area and relative purchase price to what the real price should have been you may net $0 profit in the short haul. Homes are more 10 year+ investments, only recently in this market have quick gains been realized, which was tied to the low rates which are now on the climb.

The reason your guy likes them is the same reason lease guys like leasing cars. You can get someone in the ride that normally couldn't. Chances are at the end of the term he is upside down with mileage and wear excesses and has no money for the next car and has to figure out a way to pay out $3k in excess or buy the car back at a premium.

You don't want to lease a house with a mortgage, you may as well rent short term.

However, specifics would be the only way to judge your deal.

 

[Vic]

Originally posted by: Rob9874
Money put towards home equity grows at a rate of exactly 0% per year.

This is wrong. Every dollar of equity that you put into your home is a dollar that you don't pay interest on. Simple accounting: home equity goes in the assets column, your home mortgage goes in the liabilities column.

And if I meet with a customer to go over their loan application, I expect them to sign the 1003 application, GFE, and disclosures, and to provide me with the documentation that I need to submit the loan for them, or else the process for them ends right there. I don't like having my time wasted. The initial application and disclosures don't commit you, the lender hasn't even decided if they're going to lend to you yet!

 

[zephyrprime]

My sister works for GMAC RFI - a mortgage company. Business has dropped by half compared to last year. The bubble is bursting and now is a bad time to buy a home.

 

[alkemyst]

Originally posted by: zephyrprime
My sister works for GMAC RFI - a mortgage company. Business has dropped by half compared to last year. The bubble is bursting and now is a bad time to buy a home.

It's always a good time to buy a home...the market that's being affected is refinances.

It's a bad time to buy products that adjust or getting into a program with a low rate that doesn't take care of principal.

 

[Double Trouble]

There's a couple of key points not being factored into the equation.....

First, if your property value rises, it means (provided you stay within the same general area of the country) the price of the house you're moving to (the house you plan to buy in 5 years) will rise at the same pace. As such, most appreciation in the value of the house is swallowed up by the increase in cost for the next home. In the meantime, if you have only been paying interest, you've built no equity, and you could set yourself up for a nasty potential situation with rates in 5 years.

With regard to investing money rather than putting it in the house, you're correct in your analysis that if you put away a certain amount each month you'd have the same amount (or more with interest) at the end of 5 years. However, most people do not have the discipline to do that, and end up making only interest payments. Then, when they need cash, they have no equity and no nestegg in the bank either. Very dangerous. Of course, if you're absolutely certain you will make those extra payments........

Another thing is that the interest rate on interest only loans is generally a notch higher than what you'd be paying on a 'conventional' loan. You'll be paying more for borrowing the same amount.

Bottom line: if you're absolutely sure you'll be moving out within 7 years (or even 5), then get yourself a good 5/1 or 7/1 ARM. You'll get the best rate, and you'll build equity.

I work in corporate finance now, but I used to work at a bank and I saw plenty of people who ended up in terrible situtations where they got royally screwed. I'm not saying that happens to everyone, but when it comes to a decision as big as your house and the financing behind it, think long and hard and be careful. The promise of low payments (interest only) is very tempting, especially when you're just starting out, but there are lots of potential pitfalls.

 

[1cito]

Originally posted by: Vic

Originally posted by: 1cito
whats to stop someone from taking the interest only loan (for the lower interest rate) and then just making the extra payments. isn't this a better way to lock in a lower interest rate?

Because if you plan on paying principal, there are other and better ARM products out there that offer a lower interest rate than just an interest only program. The best IMO is a conventional Fannie Mae 5/1 ARM. Get a rate in the 4's today.

I dont like ARMs because the interest rate may go up a full point or two at some point. For an interest only loan, is the interest rate locked for the life of the loan? if it's locked then why do a conventional 30 year loan? why not take the lower rate (and pay the principle)?

Vic are you a loan officer?

 

[Rob9874]

Update: We got approved for $210K. Want to stay between $175K-$200K. Doubt we'll do interest only. Not right away anyway. We got some real numbers from our mortgage guy. $200K at our interest rate is about $1700/mo after taxes and insurance. Interest-only is about $900. The reason is not only because you're not paying towards principle, but the interest for the first 5 years is 3.75% (but requires a credit score that we don't quite have).

 

[Mill]

Originally posted by: 1cito

Originally posted by: Vic

Originally posted by: 1cito
whats to stop someone from taking the interest only loan (for the lower interest rate) and then just making the extra payments. isn't this a better way to lock in a lower interest rate?

Because if you plan on paying principal, there are other and better ARM products out there that offer a lower interest rate than just an interest only program. The best IMO is a conventional Fannie Mae 5/1 ARM. Get a rate in the 4's today.

I dont like ARMs because the interest rate may go up a full point or two at some point. For an interest only loan, is the interest rate locked for the life of the loan? if it's locked then why do a conventional 30 year loan? why not take the lower rate (and pay the principle)?

Vic are you a loan officer?

Depends on your situation. I'm fixed at a low rate for 5 years, and then after that it can rise. I won't be in this house longer than 5 years, and even if I am the rate can only rise to a ceiling of 1 3/4 quarters is a year I believe. It may actually be less.