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Four Great Reasons to Choose an Interest-Only Loan
Somewhere along the way, it’s been burned into our brains.
Interest-only loans are bad.
The endless Chicken Little cries of columnists and talk show hosts have scared a lot of people. If you bought recently, and if you got 100% financing, and if real estate values tumble, and if you have to sell, and if you took an interest-only loan…… you could be in trouble
Could be?
If all those things happen, you will be in trouble, but it won’t have anything to do with what kind of loan you have. Let’s be different for a moment and talk about four things that interest-only loans do really well.
Pay all the principal you want. Interest-only loans don’t prohibit paying principal. You’d be surprised how many people tell me, “We don’t want one of those; you never pay down principal!” What, the bank won’t take your money? Pay as much principal as you like, when you like. Treat it like a regular loan if you want. The interest-only part is just an option.
Buy a bigger house. Interest-only loans can shave a couple of hundred dollars per month off the payment (at least in Sacramento, your mileage may vary). But because buyers qualify at the lower payment, the doors of home ownership open a little wider. For some, an interest-only loan means having breathing room when things get tight. For others, it means buying a bigger house, buying in a better neighborhood, or getting your kids into the right schools. Think about that. Those happen to be the same qualities that cause homes to hold value better and appreciate more. Stephen Covey says “begin with the end in mind.” I say “buy with the sale in mind.”
Shape the payment. I use interest-only loans to give payments a shape. Look, people’s incomes are rarely flat. Many folks have unpredictable amounts of overtime, bonus, or commission income. Young people have growing incomes. Retiree’s incomes shrink. Single people get married. Marrieds get single. It’s great to give payments a shape that looks a little more like their life.
Save money. Did you ever wonder what happens when you make a large principal payment on a traditional loan? Nothing. At least for a long time. Payments don’t change, interest costs don’t drop. You have to refinance to make that happen. And that cost more money. Sure, if you keep the loan long enough, you’ll skip a few payments and save some interest 25 years down the road. But will you even be in the house then? On the other hand, interest-only loans respond immediately to a principal paydown. Your payments drop next month, your interest costs are lower, and you didn’t have to refinance to do it!
I hope interest-only loans look less scary now. I’ve got more to say on this topic later, so keep your ear to the rail. While they’re not for everybody, they might be the right tool for your needs. As one client recently observed, “traditional loans are almost interest-only the first few years anyway, aren’t they?” Maybe that should be reason number 5.
Got questions; need advice or help with your loan? Call or email me. It’s what I do.
December 29th, 2006 at 12:11 am
[…] First, let me start with an observation based on personal experience. Most consumers believe that interest-only loans are bad. I rarely encounter a client whose mind isn’t already closed to the notion when the topic first arises. The press has done an effective job of scaring the consumer by associating interest-only loans with the real estate bubble and predatory lending. But interest-only loans—particularly the 30 year fixed variety—are wonderful financial planning tools, and they are safe. Read Four Great Reasons to Choose an Interest-Only Loan. […]
December 29th, 2006 at 6:55 am
Sounds like 4 good reasons for buyers to consider an interest only loan.
My wife and I are searching for a new house now; we’ll take a closer look at the interest only products available.
January 9th, 2007 at 1:22 am
Jim, keep an open mind about interest-only loans. One of the things that caught many people off guard was that some of these have a very short fixed rate period. At the end of that 3 or 5 year period, two things happen. The rate begins to adjust, and principal is amortized in over the remainder of the 30 years.
I mostly use 30 year fixed rate loans with the interest-only option. The rate never fluctuates, and the borrower can make interest-only payments for up to 15 years before the loan begins to amortize. I don’t know a soul who has had a mortgage that long. It should be plenty of time.
Marc
April 14th, 2007 at 11:08 am
[…] Others have blogged this topic and the Fannie Mae link will get you to the general stuff, so I’m going to restrict my comments to points I don’t see made elsewhere. Some of the issues—income limits and the interest-only option—are not covered on the Fannie Mae site, so I’m going to confirm them on Monday. And keep in mind that what follows applies to the use of MyCommunity Mortgage for 100% financing. […]