Interest Only Mortgages
Some day on your webpage you need to talk about [Interest Only]
mortgages. I know lots of cons but are there any pros[?]
Now, as stated in the title of this blog, I will have opinions the many things that I am eminently unqualified to talk. In regards to this particular question, I wouldn't go so far as to say "eminently", but I am by no means an expert. Based upon what I do know...
Interest only mortgages are advantageous for only a certain select few, and for those few can be very advantageous. However, the availability of interest only has tarnished the reputation, gain simply because most getting them have no business having one. Two groups of people come to mind that the interest only would benefit. Since interest only mortgages are typically well below market rates for fixed mortgages and somewhat below ARM mortgage rates the cost alone would make it attractive to anyone, HOWEVER, I am of the firm opinion that the only groups of homeowners that should even think about getting one are those who have comfortable equity in their home (i.e greater than 20%) and are viewing their home as an investment ONLY or those who have the disclipine to continue to make a "fixed" type payment to capitalize on the lower interest cost. You should note that both of these types of people generally are more sophisticated borrowers and generally are at least upper middle to upper income borrowers.
Those of the first type, are generally planning on selling their home within 3-5 years and netting the gain as an investment to reinvested into another home. Why interest for these people? Because within 3-5 years the amortization schedule is still mostly interest anyway so why pay a higher rate, even if it is fixed? These people can generally see how much interest rates would have to rise for them to even get close to a fixed rate and are willing to take on the interest rate risk. Also note that these people can generally afford the traditional fixed rate mortgage payment, just choose not to use the payment difference on this particular investment (the home). These are true time value of money people. Money in my pocket now is worth more than later.
Those of the second type again can make the traditional mortgage payment...and do, that's the discipline (In other words, the payment made is of the same amount as one that is caluclated as an actual amotizing loan). They are smart enough to capitalize on the lower interest only payment while continuing to make the "whole" regular payment, which in turn reduces the principal balance faster. The forward risk is at what period of time should the homeowner decide to convert to a traditional mortgage, if ever? The real risk becomes hindsight because short term variable rates could eventually climb higher than what the homeowner could've fixed in at, say three years prior. One would think that the interest only interest rate will
always be lower than the then current fixed rate option, but to maintian the aggressive payment these people should augment their payment with addtional dollars if interest rates were to take a sharp spike.
Any person that doesn't fit these two discriptions has no business even looking at an interest only option. Unfortunately a lot do because it means they can get into something bigger than they can afford, and that's just a time bomb waiting to explode. But hey, the've kept up with the Jones's.
In all, I think Interest Only mortgages are just another ploy for brokers to go after unsuspecting individuals (or highly uninformed at least) to pad their pockets. These types of mortgages are not all bad, as evidenced by the types of homeowners that can benefit. However, I would bet money that the vast majority of homeowners that have this type of mortgage do not fit in the above noted demographic. For another day, another subject that pisses me off...Flexible Payment Mortgages.