Traditional Versus Interest Only Home Loans
by Lois Center-Shabazz
Once only a tiny percentage of the mortgage market; interest
only mortgages consist of about 10% of the current market. And mortgage
companies seem to advertise them quite a bit these days.
An interest only mortgage loan is when you pay interest only on your mortgage
loan for a specified period, usually 5 or 10 years. During this period none of
the principal is paid, unless you put a substantial amount on the down payment
toward principle. If you have an interest only, no down payment loan you are
paying absolutely nothing on the principal. At the end of the 5 or 10 year
period your mortgage loan is amortized over the remaining period of 20 or 25
years, for a 30 year loan. So for example, if your interest only period was 10
years, your principal loan will be amortized over 20 years.
If you have a 100% interest only loan, you are not building up equity in your
home. In essence you are leasing a home for the tax deduction. The interest
payments are tax deductible, but at the end of a 10 year period your payment
could increase by 50% when the loan is re-amortized.
This type of loan would work in rare instances. One is with investors who plan
on fixing up a home that they will sell quickly. It may also work for someone
who will probably make a lot more money in 10 years than currently. Say for
instance a physician who is a cardiovascular resident, but when he or she
finishes will be able to cover the increased mortgage after 10 years because of
a large spike in income as a cardiovascular surgeon. Also, someone who knows
they will move in 2-5 years, as this is only a temporary stay.
Getting an interest only loan will allow homeowners to buy much more house than
they could afford with a traditional loan. But does this make sense? With the
more expensive home comes the more expensive costs. Such as the car that fits
the neighborhood, and the private school everyone sends their kids to. Of
course, most should know that with a bigger home comes bigger maintenance cost.
Since most housing experts feel we are at the top of the housing markets as far
as home values are concerned, this is risky. Say the housing market decreases in
value by about 20-30% like it did in Southern California in the early to mid
90's. You will be left with a minus value in your home and a monthly mortgage
that will increase in 5-10 years. When home values are less than the loan
against a home, the home becomes very difficult to sell, especially when you
have to pay the difference from your pocket.
My picture of wealth building is finding a home you can afford to buy with
current income, placing a down payment on the home, and paying on interest and
principal. Building equity, paying as much of the principal as you can possibly
afford, while placing money in a savings account, retirement account, paying
bills on time, and keeping credit accounts to a bare minimum.
Lois Center-Shabazz is the author of the award-winning book, Let's Get Financial
Savvy! ISBN #0971979502, and founder of the personal finance website,
www.MsFinancialSavvy.com