"If you're going to be short-terming, why even bother paying down principal?"
chicagotribune.com
Interest-only loans drawing greater interest
By Lorene Yue
Your Money staff writer
Published October 10, 2004
Home buyers who want lower mortgage payments and a pricier house are fueling the interest-only loan craze.
The product, which lets you pay just the interest on a loan, isn't new, but mortgage brokers and banks have been seeing stronger demand as attitudes toward home loans have changed.
An interest-only loan can help you buy a more expensive home or give you access to more disposable income, said Ernie Grue, vice president of Sandy Spring Bank in Columbia, Md.
You'll pay $1,774.61 in principal and interest a month for a $300,000, 30-year fixed-rate loan at an interest rate of 5.875 percent. With an interest-only loan, your monthly payment would be $1,468.75, or a savings of roughly $306.
There are downsides.
"There's good and bad with it, as you can imagine," said Steve DiMarco, director of marketing sales for Mid America Bank in suburban Chicago.
You could overextend yourself if it's the only way you can afford to buy a home, he said.
Or hang onto the loan long enough, and your payment could swell--the interest-only option isn't indefinite.
Most lenders will give you an interest-only option for 10 years. After that, your loan amortizes for the remaining years, and the shorter amortization period means a higher payment if the principal remains the same. A $200,000 loan over 30 years will cost $1,199.10 a month at a fixed rate of 6 percent, compared with $1,432.86 over 20 years.
An interest-only loan is not an option for everyone. Here are two reasons to consider it, and two reasons to pass it up.
- On the move. An interest-only loan could be the way to go if you're not planning to stay for long in your home.
Borrowers have held mortgages for less than seven years, said Doug Duncan, chief economist for the Mortgage Bankers Association. And in the initial years, most of your payment goes toward interest. With a $200,000, 30-year fixed mortgage at 6 percent, you'll pay $11,933.19 in interest in the first year and $2,456.01 toward principal.
"If you're going to be short-terming, why even bother paying down principal?" DiMarco said.
- Sporadic cash flow. Interest-only mortgages may appeal if your income changes throughout the year because of bonuses and commissions. Just because you are paying interest doesn't mean you can't put money toward the principal. If one month you get a $3,000 bonus, you can kick that toward your principal and lower the amount you've borrowed.
- Equity. There are differing thoughts on building equity with an interest-only loan. If the home never increases in value, you won't build any equity by paying off just the interest. And you're underwater if the house depreciates, DiMarco said.
Although many have seen their home values increase, they should be poised for slower growth. Prices on existing homes grew roughly 6.4 percent in 2004 and new homes about 9.7 percent, Duncan said, but both are estimated to rise between 3 percent and 4 percent in 2005.
- Moving target. Make sure you understand what kind of loan you are getting (some have interest rates that adjust monthly), and how your payments might change. There are some that could add to the amount you owe.
"Anytime the interest rate adjusts at a different rate than the payment adjusts, then you could have negative amortization" if the total amount you've paid at the end of the year is less than the balance due, said Doug Perry, senior vice president at Countrywide Home Loans in Calabasas, Calif. In that case, the shortfall gets added to your loan amount.
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