Interest Only Home Mortgage Loans
One of the contributing factors to the current subprime lending market crash and crisis is the prevalence of interest only home mortgage loans. Interest only home mortgage loans are interesting for several reasons. One of the main reasons is that such loans are considered “creative financing” that allow those who might not be able to afford a home access to buying a home. And it allows those who cannot afford a bigger home mortgage payment “more house for the money.” But in reality, as many are finding out the hard way, it really isn’t “more for less.”
How interest only home mortgage loans work
Interest only home mortgage loans work by an arrangement by which the buyer pays only the interest on the loan for a set number of years. This may seem like a good idea to start. After all, the interest may only be $500 to $800 per month, as opposed to a home mortgage payment of more than $1,500 per month. This means that many (especially those just starting out) can get into a bigger house, since it looks like the debt-to-income ratio is lower than it really is.
So, you start out with lower home mortgage payments each month. And, the mortgage interest rate may even be lower to start. Many interest only home mortgage loans start with a lower mortgage interest rate to further sweeten the deal. That rate is usually introductory, and it goes up after six months to three years. So your payments adjust upward. Also, this is also the time that the interest rate goes from fixed to adjustable, making your home loan an ARM. But you are still only paying the interest, and it is still a lower payment.
The real kicker comes five to seven years (maybe even ten years!) down the road. You haven’t been paying on the principal, and you have to start sometime. This means that after the initial period is over, you are required to start making payments on the principal as well as the interest. This can double — or even triple! — your monthly mortgage loan payment. And this is where many people have found trouble. The selling point is the low initial mortgage loan payment. The clincher is that supposedly, you will be earning more money in five, seven or ten years to handle the much larger payments. Unfortunately, that did not happen for most people. Around the year 2000, interest only home mortgage loans really took off. Now, we are seeing the later effects as those who took the loans are finding that they really can’t handle the larger payments.
Other disadvantages to the interest only home mortgage loans
The larger payments later is just the tip of the iceberg. There are other disadvantages to interest only home mortgage loans. One of them is the fact that you are often in an ARM. This makes it difficult to budget each month, since your home mortgage loan payment changes constantly. Another problem is that you are not building any equity in your home. Equity is built as the home increases in value and as the principal is paid off. Paying interest only does not contribute to equity. You will build equity, or ownership, in your home much slower. This means if you sell, you could end up with not much more than what it takes to pay of your mortgage loan. Interest only home loans can destroy the value of your home as an investment.
There are other alternatives to interest only home mortgage loans. The main one is carefully considering what you can afford, and stick to buying a house in your price range. A price range that includes a more traditional fixed-rate loan.
