More Interest in Interest-Only Loans
Yet, interest-only loans are fast becoming a favorite among new homebuyers, thanks to the flexibility they offer. In essence, the purchaser becomes a homeowner right away, garnering all of the tax breaks that go with home ownership, yet has five years to make higher payments, refinance, or earn additional money to meet the then-higher mortgage.
Mortgage broker Kevin Casey says the interest-only loans are ideal for families who want to move up, but don’t feel they can do so. “There are a lot of people who feel trapped in their homes,” he explains. “Maybe they bought their home, a smaller, starter home, for $250,000 or $300,000 some time ago. They’re now busting out of that home, but when they go to look at the homes they want, those homes are going for $600,000, maybe $700,000, or more,” he explains.
In this situation, Casey says the interest-only loan gives the growing family some options. “Let’s say you have a couple with a home now worth $300,000. They sell that home, and apply the equity to their newer, $800,000 home. They also take an interest-only loan for the remaining $500,000,” he says.
What happens once their new, move-up home is purchased? Casey says that will depend on several factors. “If rates go down [in the five-year interest-only period], they can refinance. And that happens very frequently – most homeowners will refinance within five years, so why lock yourself in for 30 years when you will refinance anyway?”
But the interest-only scenario still makes some purchasers a bit nervous, so Casey also looks at what he calls the worst case scenario – which is still not too bad. “First of all, they have had five years to earn more money, and save, if they choose. They have also had five years of tax savings. That being said, if they haven’t refinanced, they can change over to another loan program, with some flexibility, for several more years, and wait for rates to fall.”
Another twist on the interest-only loan is the Home Equity Accelerator Mortgage from Sterling Mortgage. Peter Holmes, a mortgage broker with Sterling, says this gives home buyers the best of both worlds. “This product is unique, because it gives the home buyer a long-term, fixed interest rate, but for the first 10 years, it has a lower, interest-only payment.”
The loan is particularly suited to home purchasers who are buying a “handyman’s special”, or who would like to do extensive remodeling. It also allows buyers to purchase a home they might otherwise think of as out of their range.
“In addition to the flexible payment terms,” Holmes says, “the loans have the ability to be used like an equity checking account. You can write checks from them, and essentially, get the home’s equity when you need it.”
While those buying a home are increasingly using the loan, Holmes says those refinancing are also considering the product, which is a borrowed idea from Great Britain and Australia. “In the UK, one fourth of all homes purchased are using this type of loan, and one third of the homes purchased in Australia are doing so,” he notes.
There are some caveats, of course. Without careful planning – and careful adherence to a plan – the homebuyer could wind up in a financial squeeze when the mortgage payment increases to include both interest and principal. Moreover, some loans require at least some money down.
When it comes to the scenario at the end of 10 years, Holmes, like Casey, remains optimistic. In addition to refinancing options available, Holmes notes that real estate in the San Francisco Bay Area continues to go up, up, and up. “Alameda County alone has seen a yearly growth in home equity of six to nine per cent over the past several years,” he explains, meaning a $500,000 home might gain an additional $25,000 to $50,000 in value each year.
