The New Fad
by Judy Stern
Loan Consultant,
First Security Loan
Loan Consultant, First Security Loan
Every couple of years there's something new that comes along whether it's the Atkin's diet or pink hair or even something as retro as surfing. And, fads are usually brought into favor for the obvious reason - if you promote it, they will buy. This adage includes new loan products that lenders are promoting for the obvious reason - people will buy it. Lately there's been a lot of discussion about interest only loans and the evils of such a loan. Even though it's a new concept to many buyers it has been available in other forms of financing. And, if managed properly, isn't as evil as many people suggest.
Interest only loans have been available as an option on adjustable rate mortgages (ARM's) that go by the name "option ARM's" or "deferred interest ARM's" or "negative amortization ARM's". It was always available as one of the 4 methods of payment on this particular loan. These loans were popular with individuals who usually had a limited housing budget and allowed for greater flexibility toward affording a home. Lenders recognized the benefit of these loans since it allowed more people to purchase and afford homes using the interest only feature. Lenders determined that there might be a way to build on the benefit of making interest only loan payments. Hence the idea of interest only loans with a fixed period of time, such as 3/1, 5/1, 7/1 and 10/1 ARMS. These loans allow borrowers to make interest only payments for the fixed period of time followed by an adjustable rate mortgage (which refers to the "1" after the larger numbers). With the advent of these types of loans came, naturally, 1 & 6 month adjustable rate mortgages with interest only payments.
So, this new demon, interest only loans, is what has allowed almost 70% of buyers in San Francisco, Marin and San Mateo to afford homes. With the increasing value of homes in the Bay Area, these interest only loans are not such a bad idea. As the economist for the California Association of Realtors suggested, the performance of the housing market over the long term doesn't present a concern. And, when these loans are managed properly, it should be viewed more as a financial vehicle. For example, if you were to have a loan of $ 800,000 which represents 80% of a $ 1,000,000 home, with an interest only loan at a rate of 5.625% and fixed for 5 yrs., the monthly payment would be only $ 3,750 compared to a fully amortizing loan (at the same rate) that would have a monthly payment of $ 4,605. The difference of $ 855/mo. when put towards the mortgage, if desired, would pay down the principal balance by $ 51,300 over 5 years. Or, better yet, put into a retirement account that may earn compounded interest over those years while your real estate appreciates in value.
It is important to begin to consider your loan as a vehicle for gaining more financial freedom. In other words, have your money work harder and smarter for you using these interest only loans. We are fortunate to live in an area where home values have appreciated into the double digit area and, if that's the case, why not put the savings from an interest only loan into a financial vehicle that will provide some benefits for you at a later time, like your golden years.
