A friend asked me, and since I have little knowledge about it… so here it goes
Whats the downside of going for an interest-only payment schedule for home mortgage? What he tells me its $800/mo for $300k loan. The APR is about 8%, and the principle + interest will start after 2 years. There are some points involved too.
Is it a good option for a first time buyer who is cash flow short right now from a monthly POV. Expects better position 2 years down the road and also, may refinance at that time. Depending on the rates.
1 getting more house thanu can afford right now..although you won't build equity during the interest-only term, .
Using the funds from the savings in a diff way..e.g. pump more into 401K for a few years so you van better the impact of compounding..or use them for a business venture.
more tax advantages because your house is more expensive so you are paying more in taxes thus higher tax writeoffs. may get touted as a huge selling point for interest only mortgages, but you have to investigate the pros and cons of it..difference may not be as big unless u are getting a place which is significantly more expensive than what u woukd have acquired ona reg mortgage.
Real estate market has its up and downs and if the guy has to sell it during a downturn and all he has done is made interest payments, he is in trouble. watch out in california because the real estate in some areas is def overvalued. however if he just pays interest and the market goes thru the roof and he sells, he has come out ahead big time with minimal investment
he also has to do some math..in the long run is it better for him to get a place at current rates and stick with it, or get an interest only and then try to refiance in a few years..risk is who knows how much higher the rates may be when he refinances.
wells fargo is a leader for interest only loans...tell him to talk to these guys they will guide him. I think the site may even have calculators for u to do scenario analysis.
Fraudz pretty much covered it, interest only loans are used very frequently in commercial transactions.
The most worrysome aspect of this is that when arrangements like this become commonly available, it is often evidence of a "top" in the Real Estate market. ie, every buyer who can conceivably buy has bought. What this amounts to is speculation that if this guy needs to sell, that the house will be worth 10% more than it is today, to potentially cover closing costs.
He should only do this if he is VERY secure in his job.
I'm not sure I understand the benefit of this kind of loan. Aren't average 30 year fixed rate mortgages around 5.5%? If so, on a typical loan, wouldn't a 5.5% mortgage with principal and interest payments actually be less than an interest only 8% loan? Even if the typical mortgage would be higher on a monthly basis, I can't imagine that it would be significantly higher.
Once you factor how much more you will pay over 30 years at a 2.5% higher interest rate, it sounds like a very bad long term deal with a short term benefit that I really don't see.
The lender clearly benefits from this deal. But what kind of borrower benefits?
Myvoice… what I understood, the buyer gains from having to make lower payments for some time. So theoretically, he can buy a bigger/better house without completely screwing up his monthly budget, right now.
The point about building no equity for 2 years is correct. The flip side is that the house may appreciate, and if it appreciates more than closing costs, the buyer may actually make some money and move to another house with a normal mortgage in 2-3 years time.
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*Originally posted by Fraudz: *
Mv thats why i questioned the interest rate, it does not look right.
the borrower is just able to get more of a house then he may be able to afford otherwise at this point. thats the biggest draw to these deals.
anyways faisal that 8% sounds incorrect.
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If the interest rate is correct at 8%, how does this kind of transaction enable the borrower to get a more expensive house? I can see how low down payments and ARMs enable a buyer to do this but not this kind of arrangment. In the first couple of years of a mortgage, the amount of your monthly payment that goes to principal is a pittance anyway.
I have heard that a home buyer can save a tremendous amount of money over the duration of their mortgage by actually overpaying in the early years of the mortgage with the amount of the overpayment being applied to principal. I was really surprised to see how much money was saved by even paying a small amount like $50 extra each month.
I highly doubtthat the rate is 8%, i thik Faisal just pointed that out as well, otherwise it makes no sense because as u stated what i can pay in interest and principal at 5% would be similar to interest only at 8%
The reason it allows a person to get a more expensive house is because lenders go easy on them, the ratio of their pay to their payment is pretty good etc.
i have a good pal in mortgage business and he calls it yuppie money :)
endowment policy is a pretty UK centric word so I dont know if US gupsters can help u. is it a with profits endowment or not? that makes an impact.
Endowment policies have some issues and that is reflected in public opinion, most people dont even know that they can sell an endowment policy. It is possible to make a profit on the endowment policy depending on the individual policy.
The issue with making profit is that sellers get hit with the early surrender penalties which can wipe out their advantages and as i stated many people dont know they could trade em..so they only surrender it.
Better option is by selling a policy in the traded endowment market..u can make 15-40% more in that route rather than surrendering it to the life assurance company.
I know people who have done well as well as done poorly when they sold the TEP i.e. traded endowment policy. timings, the specifics of the initial policy and valuations, but if you are in that boat..explore various options with market makers, but surrender only as a last ditch option.
I agree with MV here( I cannot believe I just said that :D). When I bought my house 3 years ago, I did not explore the option of 15 Year mortgage. Hence paid a lot of money in interest and not much equity. This April I refinanced to 15 year mortgage and pay only $50 extra and already have more equity built up than last three years combined. I will advise against a transaction where the money only goes to interest. You will be better of waiting and saving some money for the down payment so you can afford the house you want.
kaleem yes but with the 15 year re-fi u also tookl advantage of the lower rates now and thats why its only a $50 difference. Otherwise if u were financing right now..u can go for a 30 yr, and choose when u want to pay extra..the diff is a couple of hundred per month. u can pay it early if u want and the diff in 15 vs 30 yr rate is not going to be a huge issue, what it will protect u from is that u are not tied to the higher payment amount, in the event cash is tight for whatever reason.
when i refi'ed my previous place i could do 15 yr and be paying less per month than i was paying for a 30 yr mortgage financed in 2000. I did nto bother to do that since I knew I was going to sell the place.
the interestign thing as i have always maintained it that once we look beyond charged events such as foriegn policies and in kaleem's case why the titans suck, we have more in common than we realize. after all we are all humans with our set of responsibilities to ourselves, our employers, our communities, families, mortgage bankers :) etc
Interesting thing just happened, one of my pal's bro in law moved to a diff city for work, his old place was financed with interest only dealio for a few years and now the higher principal and insurance hits..except he is unable to sell the place and will take a loss since teh city this house is in has a real estate slowdown..from his estimates any savings he made by paying less due to interest only pmts will evaporate and he may actually end up in a hole after he has sold the place for a loss.
So, how do you think it will work, if on the contrary, the real estate is expected to not only go up, but go up higher than expected, because its depressed lately and the prices are low for the value.
He could do good if he is planning to keep it for a few years and then plan to walk away, otherwise if he wants to stay there and chooses to refinance to a regular mortgage in a few years he is subjecting himself to teh risk that the rates will have gone up higher.
at the same time, if his goal is that he wants to get in a house and stay there for a few years and sell it at a profit..and then get something more permanent, if the prices of properties he is interested in at that point have gone up by approximately the same level then its a wash, but he may have higher interest rates to deal with then.
Additionally with rates moving up affordability will decrease and people in general will flock to more affordable homes and thus the demand and supply issue will increase the rate of growth of more moderately priced homes while the larger ones may see a drop or a slower growth rate.
with rates going higher ..the more expensive homes may be harder to sell then they are currently, plus they will compete with new contruction as well. the price of the property is not the only factor to consider.
a realtor may just try to sell him the most expensive place possible because the commission check would be higher, dunn matter how teh guy is financing it..he should talk to some real estate advisors otherwise who can give him a better idea of what the real estate picture is in the area he is looking to buy. Although real estate prices have been depressed in some areas..they were also artificially high in the same areas..would they get back to those highs again is a question that is tough to answer.