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May 2, 2002
"Interest-only Mortgages"
Host: Pretty much the whole world expects the Federal Reserve to start raising interest rates at some point in the next few months. That's not necessarily good news for those in the market for a home mortgage. But in this edition of "The Road To Riches," personal finance expert Jordan Goodman says there's something that could just help: interest-only mortgages.
The latest hot trend in the mortgage industry is to offer homeowners who can't afford big payments mortgages on which they only pay interest for the first five to 15 years.
The people who are typically taking on interest-only mortgages are higher-income -- using it to buy higher-priced homes. For example, Wells Fargo reports that its average interest-only mortgage is for $560,000, triple its average mortgage size. The reason people commit to interest-only loans is that the mortgage payments are considerably lower than traditional interest-and-principal mortgages for the first 5 years. For example, for a $500,000 loan at 6.3 percent, an interest-only loan would cost $2,646 a month, versus $3,111 for a traditional loan. Because the monthly payments are less, buyers figure they can afford a bigger and nicer house than they would otherwise be able to look at. Also, buyers say that they are maximizing their mortgage interest deductions because their entire payment is deductible interest. But the big downside of these loans is that the payments jump sharply once the principal payments start. That loan that was $2,646 a month jumps to $3,329 in the sixth year, when principal payments start. Also, you have not built up any equity in the first 5 years of the loan, so if the value of your house falls, you may be "underwater" in your mortgage, with your mortgage being more than your house is worth. Of course, the longer you wait to start paying principal, the bigger the payment jumps when you start. For someone with a $150,000 30-year mortgage at 7 percent with interest-only for the first 15 years, the payment would jump from $891 to $1359 in year 16, when principal payments start. If you take out an interest-only mortgage, just make sure you can handle the payments when the amount jumps sharply in a few years, or you could end up losing your home in which you have built up little or no equity!
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