New Trend: Interest-only mortgage
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One of the newer trends in the housing market is the interest-only home loan. This loan is trumpeted as a way for a consumer to afford more house than would otherwise be affordable. Let’s look at an example. The principal and interest payment on a $200,000 home loan at six percent is $1,199 per month. However, the interest only payment on a $240,000 home loan at 6 percent is $1,200. You can see where this is going. For only $1 more per month, you can afford $40,000 more on a home loan
If only it were that simple.
After five years, that interest-only home loan is going to no longer be interest only. You may have some choices regarding your next step. One might be the balloon option. Under this option, the loan is payable in full at the end of the interest-only period. This involves either selling the home or refinancing the home into a traditional mortgage.
The risk of selling the home is that you haven’t been paying down the principal on the loan. Therefore, if you have to pay a realtor six percent to sell your home and there has been limited appreciation in the home’s value, you may end up paying out of your pocket at closing. A similar risk exists for refinancing. If the home has not appreciated adequately in value, you may find it difficult to refinance.
Another option is that the loan may convert into a traditional mortgage. But here’s the catch...the interest rate is going to adjust at the end of that five-year period just in time for you to have to make principal and interest payments. Or put another way, your payment could double or triple at that time!
Traditionally, homes are appreciating assets. Yet, there are no guarantees that your home will increase in value or to what extent that increase will be. Selling a home can be expensive and time consuming. The best approach is to buy a home on which you can afford to pay both principal and interest. That way you won’t be mortgaging your financial future.
