I'm going to meet with a mortgage guy tonight to discuss our first mortgage. I was leaning towards an "interest only" mortgage, but then my mortgage guy is really for them. So I'm pretty sure it's the way to go for us. Some friends of ours are weary about them, so I'm asking you guys to talk me out of it. I think the main reason I'm posting is to work it out for myself in my head.
For those who don't know, an interest-only mortgage defers the principle payments for 5 years. So your principle doesn't start amortizing until year 6. Because it's now a 25-year amortization (on a 30 year loan) instead of 30 years, the principle portion of your payment after the 5th year is more, making your payment more. But, if you're like us, and thinking of getting out of the house before 5 years, I don't see the downside. Worse case scenario, we'd refinance before the 5th year is up, to avoid the larger payments.
But for someone looking to get into a first home, realize some appreciation, and use that for a down payment on a second home in a few years, why not do interest only? The argument is, "But you don't have any equity in the house. When you sell, you owe what you did from day one." However, my response is that you get all the equity that appreciated. 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. About $2K of that was from the equity they paid in their payments. Another friend also bought a house 2 years ago for $122K, and just got it appraised for $175K. $53K in 2 years. Also had paid down his mortgage only $1K in 2 years. The Phoenix East Valley housing market has always been booming, and is showing no signs of slowing down.
If you're not planning to pay the mortgage off, why pay towards the equity in your payment? The money you put towards the house does not make any money. Consider these scenarios, both purchasing a $100K house, which appreciates to $150K in 4 years:
Scenario 1:
Conventional loan
After 4 years, you've paid $10K towards equity, so mortgage balance is $90K
Home sells for $150K
Profit = $60K - $10K that you paid towards equity = $50K
Scenario 2:
Interest-only loan
After 4 years, you haven't touched the principle, so mortgage balance is $100K
Home sells for $150K
Profit = $50K
The money you put towards equity doesn't grow. If you pay $10K towards equity, you get exactly $10K back when you sell it. Any profit you've made from appreciation is independent of the amount of equity you've paid towards the house. In fact, if you used that $10K over 4 years to invest in a 10% investment, that $10K would be even more.
OK, I think I'm sold on interest-only. This little exercise has helped me make sense of it. Unless someone can talk me out of it.
For those who don't know, an interest-only mortgage defers the principle payments for 5 years. So your principle doesn't start amortizing until year 6. Because it's now a 25-year amortization (on a 30 year loan) instead of 30 years, the principle portion of your payment after the 5th year is more, making your payment more. But, if you're like us, and thinking of getting out of the house before 5 years, I don't see the downside. Worse case scenario, we'd refinance before the 5th year is up, to avoid the larger payments.
But for someone looking to get into a first home, realize some appreciation, and use that for a down payment on a second home in a few years, why not do interest only? The argument is, "But you don't have any equity in the house. When you sell, you owe what you did from day one." However, my response is that you get all the equity that appreciated. 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. About $2K of that was from the equity they paid in their payments. Another friend also bought a house 2 years ago for $122K, and just got it appraised for $175K. $53K in 2 years. Also had paid down his mortgage only $1K in 2 years. The Phoenix East Valley housing market has always been booming, and is showing no signs of slowing down.
If you're not planning to pay the mortgage off, why pay towards the equity in your payment? The money you put towards the house does not make any money. Consider these scenarios, both purchasing a $100K house, which appreciates to $150K in 4 years:
Scenario 1:
Conventional loan
After 4 years, you've paid $10K towards equity, so mortgage balance is $90K
Home sells for $150K
Profit = $60K - $10K that you paid towards equity = $50K
Scenario 2:
Interest-only loan
After 4 years, you haven't touched the principle, so mortgage balance is $100K
Home sells for $150K
Profit = $50K
The money you put towards equity doesn't grow. If you pay $10K towards equity, you get exactly $10K back when you sell it. Any profit you've made from appreciation is independent of the amount of equity you've paid towards the house. In fact, if you used that $10K over 4 years to invest in a 10% investment, that $10K would be even more.
OK, I think I'm sold on interest-only. This little exercise has helped me make sense of it. Unless someone can talk me out of it.