In a pitching-rich baseball mecca like Chicago, good thing Pat Boyle is, well, up on arms.
Next month, Mr. Boyle will debut as a sportscaster on Comcast SportsNet Chicago. But before he even utters a final score, Mr. Boyle and his wife Shannon, who recently relocated from Connecticut, had to make a final decision on financing their new home just as interest rates were expected to rise.
"With a younger daughter, we want the downtown experience for a few years before we move to the suburbs," says Mr. Boyle.
Primarily because they plan on remaining in their Ravenswood townhouse for only three years, the Boyles chose a three-year I/O (interest-only) ARM (adjustable rate mortgage) ideal for those who expect to be in their home no longer than five years. An ARM is a family of mortgages, of which an I/O is an option. An ARM has a lower initial interest rate than a conventional fixed long-term mortgage and lowers monthly payments. An ARM with an I/O can offer a borrower even lower monthly payments or, as experts say, allow a borrower to "live large" as long as the property appreciates while a homeowner remains there.
Due to lower payments with short-term I/O ARMs, says Stephen T. DiMarco, first vice-president and director of mortgage sales at Mid America Bank in Downers Grove, borrowers don't have to sink all their cash into mortgage payments. They also have enough money left to invest or pay off credit cards.
That appeals to Mr. Boyle. "It frees up money to invest in other avenues and it gives you money to put back into your home. I like the flexibility," he says.
"You hear so much about ARMs today because interest-only facilities are married to them. You'll see interest-only options tied to things like three-, five- and seven-year adjustable loans," adds Mr. DiMarco. "With an increasing interest rate, the environment is going to go against you, so you have to figure out if you're going to stay in your home for a while or move."
High home prices are helping fuel interest in I/O ARMs, explains David A. Kasprisin, vice president and Chicago district manager of National City Mortgage. "As home values continue to rise, there's a squeeze on what people are willing to pay on a monthly basis, so they need to come up with more creative ways, like interest only, to get into a property," he says.
According to a recent survey by the Mortgage Bankers Association (MBA), ARM activity increased ending the week of Aug. 13, making up just over a third of mortgage applications, compared to slightly more than 23% ending the same week last year and up from 19% for 2003. Furthermore, it's forecast to jump to 38% in 2005, says the MBA.
However, Jay Brinkmann, MBA's vice president of research and economics, does not specifically attribute the increase in ARM mortgage applications to a rise in interest rates, which had fallen to 5.8% as of the end of August after going up to 6.3% in late June.
"Higher interest rates aren't necessarily driving more people into ARMs; it's just that more individuals are pulling out of the fixed-rate market to save a percentage point on their mortgage and high-end home buyers prefer ARMs because of lower payments," he says.
In any event, I/O ARMs also can be attractive to business people or entrepreneurs, who could be better off putting their money back into their businesses, Mr. DiMarco notes.
"Interest only options make sense because if, for instance, I'm an entrepreneur, the best use of my cash might be in my business. In other words, if I'm operating a business and can get 15% to 20% returns on my capital investments in the business, why shouldn't I divert as much capital to it as possible, or even address my credit card balance?" Mr. DiMarco asks.
He also says since the real estate market has been strong, "in essence, if the value of my house isn't going to drop substantially, why am I so concerned about paying it off when the principal reduction payments will basically be idle capital? So I've leveraged a property, using interest rates at somewhere in the 30-to-40-year-low range. I'd do that and utilize that capital in my business, or, if I'm not an entrepreneur, in other business endeavors."
But a borrower might not derive the full benefit of an I/O ARM if he or she remains in their home beyond the period of that option since they're not paying down their loan, notes Mr. Kasprisin. "You're only paying the interest, so it's a good short-term option it frees up some cash and lowers your payments. But after the third or fifth year, whichever your term is, you start to lose some upside. Rates can go up after the guaranteed period ends, which can impact a three-year or five-year ARM," he says.
Of course, there's no rule with the I/O ARM against making occasional payments on the principal, which, when it's financially feasible, Mr. Kasprisin encourages.
"I always recommend making the interest-only payments on the months where that's the only convenient payment to make. But there are certain times when it might be convenient to make principal reductions, maybe with a year end's bonus or commission check that's a little larger than usual, or if you're a business owner who does most of his or her billing at certain times of the year and have more cash then. You may just make the interest-only payment 10 of the 12 months, and in the other two months, make up for that year's principal in one fell swoop one mortgage payment that includes an additional principal reduction."
It's not a good idea to focus solely on chipping away at the interest, he says. "You want to lower the amount of principal you owe because that will, in turn, lower the amount of interest we collect on a monthly basis. You want to have the loan balance decline, simply because we don't know what kind of appreciation rates you might get in future. It's the safe way to hedge your bet," Mr. Kasprisin says.
It's a sure bet Mr. Boyle plans on lowering his principal. "My primary goal is to knock down the line of credit I took out, so that's where any extra money per month will go," he says.
With all their appeal, ARMs have drawbacks as well, says Mr. Kasprisin. "A home buyer is paying a low rate initially, but, almost always, even if (interest) rates in the economy don't change, that rate will adjust, perhaps to a higher level than the going conventional fixed-rate (loan)," he notes.
