Money News: Interest-Only Mortgages Growing Wildly

The June 27 issue of Business Week talks about the risk in interest-only loans on homes (where you only pay the interest, no principal, for a set period of time).  The article states that:

• 20% of new mortgages in 2005 are interest-only, up from 5% in 2003.
• The cities that lead in interest-only loans are San Diego (48%), Atlanta (46%), and San Francisco (45%).

When people start taking out loans and only paying interest, we're headed down a slippery slope.  When 20% of the people begin doing this, the slope is a cliff.

Update: I'm linking to the Beltway Traffic Jam.

Comments

[Alanna]

Normally, I would agree. And, frankly, it's not something I would ever like to try.

But. I think that something like this could possibly work in places like San Fran in the market right now. It could especially work if you plan to sell your property before you have to start paying a large principal or need to refinance.

Consider that interest only loans mean that you are not at all paying for the principal on your mortgage, and, in effect, do not "own" most of your house. You are not building equity by making house payments. However, if it is safe to assume that your property will appreciate greatly and quickly, the appreciated value would be the equity on your house. So, if in theory, you bought your current house for $240,000 on a interest-only mortgage, but the house is worth $320,000 in a couple of years, you made something of a $80,000 profit by selling. (Purely hypothetical example, of course.)

So, if you sell with an $80,000 profit, you can use that as a down-payment on a reasonably priced home with the usual 30-year fixed interest mortgage.

Frankly, I think this would be a great opportunity if your only other choice is renting in a market like San Francisco. Either way, your housing cost is going to guage you. But, when you are renting, no matter what, you are not building any form of equity. It's basically just lost money. If you go with a interest-only home purchase in a hot market like San Francisco, you have the opportunity to get some "free" money out of the process.

Again, it isn't something I would want to try or do, especially in my housing market, but in some markets and situations, some people could possibly make it work.

But it's when Joe Blow starts financing his family home in Springfield because the broker thought it was a great idea, that something like that becomes a very real issue...