One size does not fit all........interest only loans still make sense for some

By
Real Estate Agent with RE/MAX Shoreline New Hampshire & Maine

A recent blog pretty soundly condemned interest only loans as a bad deal straight across the board.

However, depending on your client's financial acumen and risk tolerance, an interest only loan might be just what they need to achieve a particular goal at the lowest costs.

I understand if you have an interest only loan and you perhaps live in southern California or south Florida right now and have a house you barely qualified for to start with financed with an interest only ARM and it starts adjusting upward, you might get financially uncomfortable or in serious trouble pretty easily. After all, who really believes a 3-4% interest rate on an ARM is going to last very long.

But if you're a well capitalized, savvy investor and you used an interest only loan to buy a house you're going to fix up and resell within 6 months, it might be a pretty good way to manage your cash flow on the deal.

Interest only loans are not inherently bad but sometimes the people that get talked into getting one because of some "advice" they may have received from Uncle Fred get in over their head and could end up going down with the ship.

My wife and I recently bought a new house. We bought it without selling our former residence.

We were able to do that because we took our equity out of the old house with an interest only loan and paid a huge hunk down on the new home.

I like to think we're fairly savvy about money and mortgages and I know we won't be paying anything toward the principal on our bridge loan. But it allowed us to achieve our goal of buying the new house and avoiding the hassles and aggrevation of trying to market our old house while we were still living there.

Now, thanks to our interest only loan we can fix up the old house at our leisure and let it be shown at a potential buyer's pleasure with no interuption to our lives. When I sell it we'll pay off the interest only loan and go on with life.

Interest only loans are not the right mortgage vehicle for everyone just like a ARM or a 30 year fixed rate loan may not the the right thing for some.

Each individual situation is different and should examined closely to ensure the best advice is given and the best financial solutions are used. 

Posted by

Jim Lee , REALTOR®, Certified Residential Specialist (CRS)

http://JimLee.com  RE/MAX Shoreline

100 Market St., Suite #200, , Portsmouth, NH 03801 Phone: (603) 431-1111 x3801

Visit New Hampshire Maine Real Estate.com to search homes, get Seacoast area information, and find out how great living on the New Hampshire and southern Maine Seacoast really is.

 

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Rainmaker
513,582
Leigh Brown
Leigh Brown & Associates, RE/MAX Executive - Charlotte, NC
CEO, Dream Maker - Charlotte, NC
Very good points, Jim.  I've found that disciplined buyers are prime candidates for interest only loans-they're not all bad.
May 11, 2007 08:31 AM #1
Rainmaker
1,402,181
Carol Williams
Although I'm retired, I love sharing my knowledge and learning from other real estate industry professionals. - Wenatchee, WA
Retired Agent / Broker / Property Manager
Jim, I absolutely agree with you.  I have a pending sale right now with an investor who will be using an interest only loan.  She is very disciplined and will probably pay extra toward principle but, for her, this loan program makes the most sense for the circumstances.
May 11, 2007 08:37 AM #2
Rainmaker
182,045
Sara Bonert
Zillow - Atlanta, GA
Real Estate Internet Marketing

Nice post.  I have a 7 year interest only on my house now, and I love it.  We know we won't be in our house in 7 years.  Why give the bank $400 in principle every month which will just sit there, when we could be making that money work for us? 

However, we got this loan as a business decision, not as a last resort to get in a house.  Big difference. 

May 11, 2007 11:01 AM #3
Rainmaker
1,317,651
Joan Whitebook
BHG The Masiello Group - Nashua, NH
Consumer Focused Real Estate Services
You raise some good points. I guess the most important thing is to make sure it is the right thing for the individual concerned.  There are certainly some instances where the interest only loan may make sense.
May 11, 2007 11:29 AM #4
Rainmaker
340,502
Ann Cummings
RE/MAX Shoreline - NH and Maine - Portsmouth, NH
Portsmouth NH Real Estate Preferrable Agent

Jim - I'm SO glad to see your post after reading all the negative stuff about interest-only loans.  Sure, as you said, they aren't for everyone, and for those that marginally quaiified for their mortgages by using these interest-only loans, they can lead to trouble.  However, as you and your wife prove, they are the perfect vehicle for many savvy buyers.  And there are plenty of others who'll be served very well by those types of mortgages.

Ann

May 11, 2007 11:42 AM #5
Ambassador
2,745,009
Lenn Harley
Lenn Harley, Homefinders.com, MD & VA Homes and Real Estate - Leesburg, VA
Real Estate Broker - Virginia & Maryland

I have buyers building a home and they either do an interest only- no ratio loan or they stay in their 17 years old town home with a new baby and 1 1/2 hours from the husband's job. 

Fact is, these are upward mobile professionals who will be making 10% more next year and the year after.  They need this loan NOW while I can get them in new construction at a very attractive price. 

In a fully amortized loan, they would not qualify.  Folks just have to have some common sense and make informed decisions. 

May 11, 2007 12:16 PM #6
Rainmaker
593,907
Neal Bloom
Brokered by eXp Realty LLC - Weston, FL
Realtor CRS-Weston FL Real Estate
I did a HELOC on my own purchase without closing on my other home and boy I am glad I sold when I sold ...1 month after hurricane Wilma and the beginning of down side of the RE market.
May 11, 2007 12:22 PM #7
Rainer
53,146
Ron Withers ----Retired Mortgage Professional
Kissimmee, FL

Jim,

Amen! Historical, year over year appreciation will build the equity position. The interest-only savings in the hands of an educated and disciplined borrower that understands the principles of leverage will produce wealth.

May 11, 2007 12:29 PM #8
Rainer
3,575
Robert Kerr
Kerr Financial - Warwick, RI

Nice post.  I have a 7 year interest only on my house now, and I love it.  We know we won't be in our house in 7 years.  Why give the bank $400 in principle every month which will just sit there, when we could be making that money work for us? 

The principal doesn't "just sit there!" It grows along with the house at the rate of appreciation.

May 11, 2007 12:35 PM #9
Rainer
34,196
David Doerr
David Doerr Mortgage Team @ Axia Home Loans - Spanish Fork, UT
14 Year Mortgage Professional

1000% agree with you!

Generally generalization statements are always wrong and represent a biased opinion. Not all IO loans are bad as well as all Option ARMs and 100% financing.

If I could recommend reading Missed Fortune 101 by Douglas Andrew to everyone that reads this BLOG.

May 11, 2007 02:53 PM #10
Rainer
54,515
Dave Cheatham
INC Financial - Bartlett, IL
you are right on.  We has people who look out for people must see what is best for each person.  We can not say % only is bad for everyone. 
May 11, 2007 03:22 PM #11
Rainer
227,199
Ed Vogt
Midwest Properties of Michigan - Grandville, MI
Grandville, MI Midwest Properties
One of my first transactions in RE was an int. only loan, and I was a little nervous about it, but because of the buyer's circumstances (and they are disciplined in finance, thanks to Dave Ramsey:)) this was the option that worked best for them.
May 12, 2007 12:25 AM #12
Rainmaker
109,785
Debbie White
Southeast Alaska Real Estate - Juneau, AK
I'm glad you brought this up, because I didn't want to rock the boat on the other post you referred to!  I feel that for the right buyer, this may be an option.... when talking to the lender, we joke that it's only for those with a credit score of over 800.  Maybe 780, but you get the idea.  A disciplined buyer with a strong understanding of their financing will most likely put extra against the principle.  These loans are quite popular in Alaska, where a larger percentage of the population makes most of their income seasonally.  This allows them to make the minimum in the slow months then extra payments when they are able.  The trick is letting go when you get a large paycheck!
May 12, 2007 02:57 AM #13
Rainmaker
246,926
Gena Riede
Riede Real Estate, Lic. 01310792 - Sacramento, CA
Real Estate Broker - Sacramento CA Real Estate (916) 417-2699
Jim, excellent and easy to understand. Great explanation and example of when interest only is appropriate and actually the best solution. Hopefully Home Buyers as well as Sellers will read this.
May 12, 2007 03:41 AM #14
Rainmaker
26,568
Scott Dovala
Ascent Home Loans - Santa Rosa, CA
Santa Rosa Mortgage and Home Loans

Jim excellent point. I have heard the same scare tactics in reference to I/O loans. Throughout my 10 years in the business, which has been mostly on the operations side and now the sales side, the problem with these types of loans has not been the program, but who and how they have been selling them. During the refi craze here in California, companies began hiring anyone to fill a loan officer spot. "Hey kid, that's the best curly Q I have ever seen on top of my Dairy Queen ice cream cone. You wanna be a loan officer?" I had even trained these new LO's trying to instill in them to use common sense when choosing a certain product for a borrower. Unfortunately they saw it as an opportunity to close a quick loan and move on, never giving a second thought whether an I/O was the right program for that borrower or that the borrower could be a future referral source. The one good thing that is coming out of this massive shakeup In our industry is the that these fly-by-night LO's are leaving the business in droves to go back to Dairy Queen.

The one thing every loan officer has to do is to get to know your borrower. Each one has an individual need. The interest-only and the option arm programs do fill a need for the right investor. 

 

May 12, 2007 04:21 AM #15
Rainmaker
325,871
Esko Kiuru
Bethesda, MD

Jim,

Each client's needs are different when it comes to a mortgage, as you emphasize. Interest only can work in many cases. I'd generally recommend one in a rising market only.

May 12, 2007 05:13 AM #16
Rainmaker
183,200
Janet Guilbault
Guild Mortgage - Walnut Creek, CA
San Francisco Bay Area Direct Mortgage Lender

I am a little overwhelmed that my Just Say No to Interest Only Loans created this debate. Totally unexpected, that power behind a featured article, but as it should be here on AR. How wonderful it has been for me to hear all of the opinions on this subject, and the strong convictions of such a brilliant audience. Wow.

My real point, and one almost everyone agreed with, is that we should evaluate each borrower, and not automatically dish up I/O just because it is easier to sell a lower payment.

And by the way, go ahead and include the San Francisco Bay area, where I do mortgages, as an area of extra caution. Values here were pretty overheated requiring a careful look at how the mortgage may impact future equity position of the borrower.

Nice post!

 

 

 

 

 

 

 

 

May 12, 2007 07:24 AM #17
Rainmaker
22,753
Theresa "Tracy" Gibson
The Gibsons at eXp Realty - Matawan, NJ
Your Needs Served

Yes, interest only loans have there place.  One place they don't belong is to qualify a buyer who will not be able to afford the loan once the interest rate resets.

I agree they are great when you need to carry to houses for a bit and/or for short term investmenty properties. 

As always, educating buyers about the pros and cons of these loans is a must.

May 12, 2007 11:34 AM #18
Rainer
13,010
Don Carter
All Star Mortgage, LLC - Haverhill, MA

The principal doesn't "just sit there!" It grows along with the house at the rate of appreciation.

Actually, this is a common misconception.  The home appreciates in value regardless of what you owe on it.  Equity grows through the combination of appreciation, and balance reduction.  But the balance reduction portion doesn't "grow".  Now if you were to take the extra $400 per month and invest in a safe, interest bearing account, you can actually "grow" the value of that money (offset by the cost of the mortgage interest).  In addition, you will create more liquidity.  If I had a choice of having $50K in equity or $45K in cash, I'll take the cash!

May 12, 2007 01:40 PM #19
Rainmaker
307,523
Ryan Hukill - Edmond
ShowMeOKC Real Estate Pros of KW Elite - Edmond, OK
Realtor, Team Lead
I have to agree for the most part. While I am not a fan of interest-only loans and feel that the majority of consumers need to stay the hell away, I also realize there are certain situations where they can be to the buyer's advantage. Thanks for a great post.
May 12, 2007 03:13 PM #20
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Jim Lee

Portsmouth NH Realtor, Portsmouth, NH
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