Once
only a tiny percentage of the mortgage market; interest only
mortgages consist of about 10% of the current market. And
mortgage companies seem to advertise them quite a bit these
days.
An interest only mortgage loan is when you pay interest
only on your mortgage loan for a specified period, usually
5 or 10 years. During this period none of the principle is
paid, unless you put a substantial amount on the down payment
toward principle. If you have an interest only, no down payment
loan you are paying absolutely nothing on the principle.
At the end of the 5 or 10 year period your mortgage loan
is amortized over the remaining period of 20 or 25 years.
So for example, if your interest only period was 10 years,
your principle loan will be amortized over 20 years.
If you have a 100% interest only loan, you are not building
up equity in your home. In essence you are leasing a home
for the tax deduction. The interest payments are tax deductible,
but at the end of a 10 year period your payment could increase
by 50% when the loan is re-amortized.
This type of loan would work in rare instances. One is with
investors who plan on fixing up a home that they will sell
quickly. It may also work for someone who will probably make
a lot more money
in 10 years than currently. Say for instance a physician
who is a cardiovascular resident, but when he or she finishes
will be able to cover the increased mortgage after 10 years
because a large spike in income as a cardiovascular surgeon.
Also, someone who knows they will move in 2-5 years, as this
is only a temporary stay.
Getting an interest only loan will allow homeowners to buy
much more house than they could afford with a traditional
loan. But does this make sense? With the more expensive home
comes the more expensive costs. Such as the car that fits
the neighborhood, and the private school everyone sends their
kids to. Of course, most should know that with a bigger home
comes bigger maintenance cost.
Since most housing experts feel we are at the top of the
housing markets as far as home values are concerned, this
is risky. Say the housing market decreases in value by about
20-30% like it did in Southern California in the early to
mid 90's. You will be left with a minus value in your home
and a monthly mortgage that will increase in 5-10 years.
When home values are less than the loan against a home, the
home becomes very difficult to sell, especially when you
have to pay the difference from your pocket.
My picture of wealth building is finding
a home you can afford to buy with current income, placing
a down payment
on the home, and paying on interest and principle. Building
equity, paying as much of the
principle as you can possibly afford, while placing money
in a savings account, retirement account, paying bills on
time, and keeping credit accounts to a bare minimum.
Lois Center-Shabazz is the founder of MsFinancialSavvy.com
and author of the 3-time award-winning personal finance book,
Let's Get Financial Savvy! ISBN #0971979502.
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