Interest only mortgages gained popularity during the recent home sales
price boom. Now that homes sales have slowed and prices have leveled out,
will the number of interest only mortgages also decrease?
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 during the recent housing boom.
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 principle 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 principle. At the end of the 5 or 10 year period your mortgage loan is amortized
over the remaining period of 20 or 25 years. So for example, if your interest only period
was 10 years, your principle 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 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 the housing market has leveled off 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 principle. Building equity,
paying as much of the principle 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.
With the recent leveling off of home sales and home values in many areas of the United
States, maybe this will be the clue that future homeowners need to get a traditional home
loan, where payments will not increase in the future and principle will be paid off from the start
of loan payments. This is typically the 15 or 30 year fixed rate mortgage.
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Lois Center-Shabazz is the editor of MsFinancialSavvy Womens Business and Finance Newsletter.
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