Interest Only Home Loans - Different Perspective

[Craig]

The other day, a fellow who works for me told my wife that he had opted for an interest-only home loan. I winced. However, when I heard his explanation, I decided he may have been very wise.

It's a fixed rate, 30 year, no amortization. BUT, when he is working, and has the cash, they pay it down aggressively ... and if times get hard, and he has to live on savings, he just pays the interest.

I'm going to check this out, and see what all the features / costs are. Anyone else considered this hedge?

 

[maddythebeagle]

no, I wouldnt do because I am close enough to paying mine off, but each person is different and has different values. Some will say, hey I can invest in the stock market, etc., but the truth is most would just spend on "stuff" - I for one want a new boat, but I should get the cash together for something like that-but please run your numbers for us and explain why you do....

 

[BUM]

IOM's can be very dangerous. The reasons above from Charles' employee sounds like the sales pitch he got from whomever wrote the loan. IOM's are now around 25-30% of all new mortgage applications nationwide.

It's a fixed rate, 30 year, no amortization. BUT, when he is working, and has the cash, they pay it down aggressively ... and if times get hard, and he has to live on savings, he just pays the interest.

"If times get hard"...gimmie a break...banks and mortgage companies have always let borrowers just pay the interest. My definition of hard times is when you can't pay anything. Then any debt is a real problem.

The dangerous aspect is how equity is treated. A young borrower is encouraged not to make principle payments. Bottom line... Follow the money. The fees and incentives for brokers are higher for IOM's. Why? Better deal for the lender.

 

[maddythebeagle]

good post I think another thing to consider is somebody like Warren Buffet is expecting lower returns in the stock market (and I can see good reason for this and pretty apparent). Even if somebody had the discipline to invest all of it at a higher rate and Buffet is right, building equity is much lower risk. I think some folks forget to factor in risk/reward in their investing decisions. Building equity is a good thing for folks and should be part of their portfolio.

Also, what is wrong with an emergency fund and home equity line of credit. You could even borrow at 0% for 12 months on credit cards if a true emergency came up.

 

[Nords]

It's a fixed rate, 30 year, no amortization.  BUT, when he is working, and has the cash, they pay it down aggressively ... and if times get hard, and he has to live on savings, he just pays the interest.

I think the key here is "when" he is working.

IOMs are like Vegas blackjack. The math is there for anyone to do, hundreds of books & websites educate us on the topic, and you can make money at it. However it's hard, boring, slogging work, the probabilities can move against you, and fewer than 1% of the "players" can exert the discipline & recall to make it work.

The casinos banks make all their money off the 99% who don't bother to learn the rules or pay attention. If your employee is among the 1% then he'll do fine. If he's among the 99% then he's eventually going to wipe out.

And I guess it's up to you to decide "when" he works!

 

[LEX]

IOM's are the precurser to disaster.  They also present a cheap source of future REO inventory pipeline for those of us who paid off our 30 year conventional mortgages and will have the cash to buy foreclosures cheap in about two - three years. 

I am of the personal view this will make the S&L failures and the real estate glut of the 1980's seem like the good old days once the stiffs on these loans start examining their positions and making the decion to walk away from their upside down debt to equity situations.

A little engineering axiom:  A perpetual motion machine can not exist.

A little financial axiom:  Real estate values can and will move down despite what your mortgage broker and real estate sales agent tell you.    8)

 

[Nords]

I am of the personal view this will make the S&L failures and the real estate glut of the 1980's seem like the good old days once the stiffs on these loans start examining their positions and making the decion to walk away from their upside down debt to equity situations.

S&Ls and banks don't carry any of the mortgages! They've all been repackaged as collateralized mortgage obligations and sold to pension funds & retail investors. So when foreclosures go through the roof and defaults pile up, the bonds will plummet and the bond-holding investors will be the only ones losing money...

 

[TromboneAl]

Do IOMs have a higher interest rate than 30-year mortgages?

 

[maddythebeagle]

I remember my neighbors walking away from their house in the early 80s when rates were so high.

I have a question, why do people have interest only rather than just renting? Neither build equity but it seems like renting would be cheaper and less hassle? Isnt their loan fees on mortgages. Or are they being duped into thinking that they will somehow build equity?

 

[Sheryl]

Or are they being duped into thinking that they will somehow build equity?

They believe that values are rising so fast they can sell and cash out with thousands of dollars in under a year. But please, let's not go back to the bubble discussion.

 

[Martha]

I remember my neighbors walking away from their house in the early 80s when rates were so high.

Good chance I foreclosed on it. Not good times.

 

[Mr._johngalt]

I remember my neighbors walking away from their house in the early 80s when rates were so high.

I have a question, why do people have interest only rather than just renting? Neither build equity but it seems like renting would be cheaper and less hassle? Isnt their loan fees on mortgages. Or are they being duped into thinking that they will somehow build equity?

I can't believe my eyes. It is absolutely possible to build equity with
an interest-only mortgage. Not only that, it is likely. Could you lose?
You bet! You can also lose with conventional financing.

JG

 

[Craig]

JG, I agree.

With respect, the proposition by my employee (a very sharp Controller) is that he is paying an interest rate equal to or less than (he believes it is less) a conventional 30 year fixed rate loan.  Whether he is working or not is certainly partly a function of the market and economy.

[Note the Financial Executives Networking Group (the FENG) has something like 20,000 members ... Controllers, VP's Finance, CFO's, etc.  I am told by one of the leaders that roughly 65% are unemployed.  These have been hard times of late for many financial professionals as companies have gone BK, merged, etc.]

He has hedged by having a lower monthly commitment than with a conventional amortizing loan, but he and his wife are currently amortizing the debt over the next 10 years.  This is about intelligently hedging against tougher times.  And, he and his family also have an emergency cash fund, invest when they can, etc. ... these choices are not mutually exclusive.

I think that assuming the bank / note holder will be willing to take interest only payments if / when times get hard is a big risk ... I would much prefer to sign a note that allows for the hedge in the contract.

So while these interest-only loans certainly have concerned me as well, the question is whether they can be an intelligent hedge if used with discipline.  When you consider this question, think about it from the standpoint of people who still need to work, and have the discipline to self-amortize the loan as they are capable.

My real reason for floating this is because I too felt concern when I heard what he had done ... until my wife filled me in on his entire plan.  He may have made a very wise decision here.

Ignore the usual problems with those who cannot plan their future ... please consider how this might actually work to the benefit of the so-called young dreamers.

Thanks.

 

[Mr._johngalt]

JG, I agree.

With respect, the proposition by my employee (a very sharp Controller) is that he is paying an interest rate equal to or less than (he believes it is less) a conventional 30 year fixed rate loan.  Whether he is working or not is certainly partly a function of the market and economy.

[Note the Financial Executives Networking Group (the FENG) has something like 20,000 members ... Controllers, VP's Finance, CFO's, etc.  I am told by one of the leaders that roughly 65% are unemployed.  These have been hard times of late for many financial professionals as companies have gone BK, merged, etc.]

He has hedged by having a lower monthly commitment than with a conventional amortizing loan, but he and his wife are currently amortizing the debt over the next 10 years.  This is about intelligently hedging against tougher times.  And, he and his family also have an emergency cash fund, invest when they can, etc. ... these choices are not mutually exclusive.

I think that assuming the bank / note holder will be willing to take interest only payments if / when times get hard is a big risk ... I would much prefer to sign a note that allows for the hedge in the contract.

So while these interest-only loans certainly have concerned me as well, the question is whether they can be an intelligent hedge if used with discipline.  When you consider this question, think about it from the standpoint of people who still need to work, and have the discipline to self-amortize the loan as they are capable.

My real reason for floating this is because I too felt concern when I heard what he had done ... until my wife filled me in on his entire plan.  He may have made a very wise decision here.

Ignore the usual problems with those who cannot plan their future ... please consider how this might actually work to the benefit of the so-called young dreamers.

Thanks.

Good post! An aside. I always believe I can think my way out of trouble,
of course this is not literally true, but mostly works for me. Especially in financial
stuff, as that was my bread and butter. I can tell that some "youngsters"
will sometimes miss the obvious, but I realize that I have spent a whole lifetime
on these issues and they are just starting out.

JG

 

[BUM]

Ignore the usual problems with those who cannot plan their future ... please consider how this might actually work to the benefit of the so-called young dreamers.

Charles,

IMHO young dreamers should dream dreams of hedges of juniper, arborvite, and hemlocks.
What say yew?


BUM

 

[maddythebeagle]

Only you know if you have the discipline to make it happen....

John G. is the superior example of discipline and intellect. but for everyone else, results may vary. I suspect that everyone thinks that they are rational with money.

 

[LEX]

S&Ls and banks don't carry any of the mortgages!  They've all been repackaged as collateralized mortgage obligations and sold to pension funds & retail investors.  So when foreclosures go through the roof and defaults pile up, the bonds will plummet and the bond-holding investors will be the only ones losing money...

Nords:

I am familair with this point, having attended an ABA seminar during the late 80's and listening to the general counsel of Goldman Sachs describing how his firm created the mortgage backed security. I did not say the banks would fold. Then and now banks sell or pledged the mortages and really only act as originators and loan service providers. This is irrelevant to the premise I attempted to make. The issue is a sudden glut of available house inventory triggering a selling panic in local markets.


Whether in the S&L days or near future, the holders or service
agents of the deed of trust, typically banks or mortgage service companies, will foreclose. If the mortgage was backed by FHA, it will become a HUD property and sold by HUD offices to cover the insurance losses. But the owners of the mortage, as investors, will get their principal back regardless. If the mortgage funding was sourced through Fannie Mae, the owners of the mortgae will collect their insurance, and the property will be placed into inventory as a REO and most likely sold through a servicing company. The owners of the mortage will likely NOT loose their principal due to the insured status of the loans. To your point the mortage will be redeemed through default, and the holder of the mortage will get their principal back, and will now have to re-invest into the present mortage market, which may be yiedling higher or lower interest rates.

I hope this clarifies the scenario I was attempting to describe as to what I believe will occur with home prices in the next 24 - 36 months in most markets. There are exceptions in every trend, and some locations will not be as impacted, but this form of "correction" is my choice for where prices will trend. Call me a real estate "bear" with my thesis based on the current declination of mortage credit quality and the price speculation that is driving most markets in the US. If you want to see the later stage (the bust part of the cycle) examine Australia, England and japan's real estate price trends.

 

[Nords]

The issue is a sudden glut of available house inventory triggering a selling panic in local markets.

We're pretty much counting on that. We'll be buying...

 

[LEX]

There is plenty of money to be made on the downside as there is on the upside, so long as your emotions are out of the equation.

 

[Patrick]

Since most people only stay in their homes 5-7 years, why not take out an IOM every time?  You're moving before the payoff, anyway.  :

 

[Patrick]

I dont know, what are the costs vs. renting since neither gain any equity?

Equity is the difference between what you paid (or owe) and the present value.  While renting you will never have any equity.  If you buy with an IOM, you can build equity through the appreciation of the property, even though the loan isn't being paid down. 

 

[ctech]

JG, I agree.

With respect, the proposition by my employee (a very sharp Controller) is that he is paying an interest rate equal to or less than (he believes it is less) a conventional 30 year fixed rate loan.  Whether he is working or not is certainly partly a function of the market and economy.

[Note the Financial Executives Networking Group (the FENG) has something like 20,000 members ... Controllers, VP's Finance, CFO's, etc.  I am told by one of the leaders that roughly 65% are unemployed.  These have been hard times of late for many financial professionals as companies have gone BK, merged, etc.]

He has hedged by having a lower monthly commitment than with a conventional amortizing loan, but he and his wife are currently amortizing the debt over the next 10 years.  This is about intelligently hedging against tougher times.  And, he and his family also have an emergency cash fund, invest when they can, etc. ... these choices are not mutually exclusive.

I think that assuming the bank / note holder will be willing to take interest only payments if / when times get hard is a big risk ... I would much prefer to sign a note that allows for the hedge in the contract.

So while these interest-only loans certainly have concerned me as well, the question is whether they can be an intelligent hedge if used with discipline.  When you consider this question, think about it from the standpoint of people who still need to work, and have the discipline to self-amortize the loan as they are capable.

My real reason for floating this is because I too felt concern when I heard what he had done ... until my wife filled me in on his entire plan.  He may have made a very wise decision here.

Ignore the usual problems with those who cannot plan their future ... please consider how this might actually work to the benefit of the so-called young dreamers.

Thanks.

Actually I am waiting for my own place to be built and I have been thinking of this very thing to finance the home.  I am in IT and while I believe my job to be very stable, I worry that may not be the case for the 15 years I originally planned to take a fixed mortgage for.  In interest only would allow me to pay down more principle in good times and in the event of a layoff, I would not be hit with the roughly 2700/mo mortgage a fixed 15 would be.  As a disciplined saver I have wondered if this might be a feasible option to protect myself against future employment issues.

 

[Patrick]

ok. you buy a house with interest only, dont you have to still put down a 20% down payment?, and risking your own money if the housing market has a downturn (if the house value goes down 20%, you are out). It might take you a few years to get back and you are thinking of interest only a short term housing plan?

It depends.  VA used to be $1 down (I don't know if it still is).  Lots of lenders will make loans with 5% or 10% down.  Yes, you may be risking some money.  Life is full of risk.  Would you rather have a stack of rent receipts?

 

[Craig]

We've decided to do this ... our Controller had a very wise idea.

Same interest rate we're paying currently, and Quicken Loans is the only source I've found for a 30 year fixed, interest-only loan (all others were 3, 5, 7, or 10 year ARM's ... no thanks).  Interest rate is fixed for the entire 30 year period.  At your option, interest only for the first 10 years, then it switches to a 20 year amortization.  We'll probably pay off all of the principal in that 10 year period, but if we can't, the payments will trend down each month we do amortize principal, and if we reach a point where we want to conserve cash, then the required monthly payment will be as lower ... drops about $50 each month for each $10K of amortized principal.  I'll regard the closing costs as an insurance premium ...

We've got significant cash reserves now, equity lines of credit, and decent but not complete retirement savings.  This step could help us reach the social security payment stage (assuming it still exists in 9 years) if times get tough.  And, based on the job market in the last 5 years, hedging seems wise.

Appreciate all of the brainstorming and feedback.

Send a private message to me if you'd like contact info for our contact ... she's done a good, very efficient job.