Are You a Gambler?

Interest-only mortgage loans are gaining in popularity, but they are definitely not for everyone. The way that many lenders are selling these loans they are exposing a lot of people to a potential gamble that they may not fully appreciate.

An interest-only loan, as the name implies, offers you the option of only paying the interest portion of your mortgage payment each month and not making any payment toward your principal. Depending on the interest rate, on a loan of $200,000 this could save you anywhere from $250 each month to even $300 or $400. That’s a sizeable savings.

The problem is, most lenders are not pushing interest-only loans as a way to save money each month. Instead they are pushing interest-only mortgages as a way to qualify buyers for more expensive homes than they would normally be able to afford. They are trying to put them in a situation where the interest-only payment each month will equal or even exceed the monthly payment on a smaller traditional 30-year fully-amortized loan.

If the homeowner is not able to invest, in a disciplined way, the money that would have been spent on principal reduction then the gamble that is being taken on an interest-only loan is magnified.

The gamble with an interest-only loan has to do with the way the loan works. Typically an interest-only loan is on option that is added onto a normal 30-year fixed-rate or adjustable-rate mortgage. The option generally allows for interest-only payments to be made for 5 years, 10 years, or 15 years.

At the end of the interest-only option the unpaid portion of the principal must be repaid or the loan is automatically converted into a fully-amortized 25-year, 20-year, or 15-year loan. When the full amount of the principal is converted into a fully amortized loan with a term less than 30-years the monthly mortgage payment can skyrocket.

The real gamble many people make is that they assume that either their wages will go up enough in the intervening years to cover the higher mortgage payments once the loan has converted to a fully-amortized loan, or they gamble on the fact that the housing market will be liquid at the time they want to sell and that housing prices will have increased..

But what if those things haven’t happened? What if you are laid off from your job? What if interest rates have skyrocketed? What if housing prices, rather than going up, actually dropped?

If any of those scenarios have come to pass you could be in deep trouble and actually be holding a property that is worth less than the amount you still owe.