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Creating Affordable Payments (Part IV): Interest Only Loans
In Part II of the Creating Affordable Payments series, we looked at 40 and 50 year loans to see if the advertising claims about lower were true, and we found that these loans do not really help, and the overall interest cost is much higher.
In Part III , we looked at Intermediate ARMs to see if they were the answer to todays most common challenge. Unfortunately, with the inverted yield curve in U.S. Treasury securities, the rate on a 5/1, 7/1, or 10/1 ARM is often higher today than the 30 year fixed.
So today lets have a look at interest-only loans to see what they can do.
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 isnt 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 loansparticularly the 30 year fixed varietyare wonderful financial planning tools, and they are safe. Read Four Great Reasons to Choose an Interest-Only Loan.
To keep to the point, interest-only loans are one of the most effective tools we have for safely creating affordable payments.
Here is a comparison of monthly payments for 30 year fixed and a 30 year fixed, interest-only loan:
- 30 year fixed, $300,000 @ 6.00% = $1799
- 30 year fixed, $300,000 @ 6.25% = $1562 (interest-only)
Thats a savings of $236 per month, a significant amount for a buyer in that price range. And that is despite the fact that there is generally a slight premium in the rate for any loans interest-only counterpart.
For any good mortgage advisor, a loan program is just a tool we use to do a particular job. An interest-only loan is a wonderful way to create flexibility and to shape the mortgage payment to better fit the clients life. The borrower can decide later whether to catch up on principal or increase their pre-tax 401(k) contributions, but for the present, interest-only loans are one of our best tools for creating more afffordable payments.
Got a question about interest-only loans? Email me.
December 29th, 2006 at 7:46 am
You are kidding, right? A “savings” to a buyer of 236 per month? How can you possibly say your are saving the consumer money, when the other 30 year loan at least offers a portion of the payment to go to the principle. You know darn well as I do that people opt for the interest only loan to barely squeeze into a house they normally could not possibly afford. They move in, have a kid or two, finance a new vehicle or two, and all of a sudden they are stuck hardly able to pay the interest-only house payment because they filled their life full of other liabilities. Of course, this is not your problem, since you are only selling them the interest only loan. Why these types of loans are not outlawed is beyond me…but I’ll save that rant for another day.
January 9th, 2007 at 12:07 pm
Hey Dale,
Again, I’m talking about creating affordable payments. As you say, there are a lot of people who buy houses they can’t afford using “exotic mortgages”. I advise strongly against this, and I’ve refused to do loans for clients when I could see that they could not afford the the future payments. Putting clients into that situation is bad for the everyone: the client, the investor, and for me. Nobody wins.
Fortunately, not every buyer is as irresponsible as you describe. There are those who’ve managed their finances responsibly and whose income might be temporarily low–one spouse laid off, a recent relocation, a young couple with degrees just getting started–such that there income will rise predictably, making the amortized payment entirely affordable.
When those kinds of folks need a way to buy with an affordable payment, interest-only loans work very well. An interest-only loans create the flexibility to give the payment a shape, but certainly not to help the borrower you describe. By the way, I primarily use 30 year fixed rate interest-only loans.
Thanks for taking the time to post.
Marc
April 14th, 2007 at 11:11 am
[...] Interest-only option on the 30 year fixed and 5/1 arm (not on the 7/1 or 10/1 arm) [...]