Risks and Benefits of Interest Only Mortgages

The interest-only loan has recently grown in popularity with home buyers, particularly first-time home buyers. Its popularity can be linked to the increase in housing prices, which have outpaced the rise in Americans’ incomes.

With an interest-only loan, the borrower pays only the interest on the loan each month for a set period of time, typically three to five years. By only paying interest, the initial monthly payments are significantly reduced.
For example, the median price of a single-family home in Boston in 2004 was $379,000.00. At a 6 percent interest rate, the monthly payment for an interest-only loan of 80 percent of the purchase price (a standard mortgage loan) would be $1,516.00, compared to about $1,817.84, for a regularly amortized 30-year loan.

The loan is attractive to buyers because it allows them to buy a house they might not be able to afford otherwise. For instance, one could buy the $379,000.00 home on a standard 30-year loan, or, for the same monthly payment, buy a $460,000.00 house with an interest-only loan.
In a typical fixed-rate mortgage, the monthly loan payment stays the same, and the principal balance due decreases with each payment. With an interest-only loan the buyer does not begin paying the principal until the interest-only period expires. The homebuyer should expect a sharp rise in the monthly payment, as it will then include the principal, plus interest at a variable rate.

One option available to an interest-owner borrower at the end of the interest-only period is to refinance. This is not a certainty, however. Refinancing depends on the housing market staying strong, and interest rates staying low. Since a lender will only loan a certain percentage of the value of a house, if housing prices fall, so does the amount of the loan the lender is willing to give. Higher interest rates after the interest only period would mean the new loan could end up costing them more than the original.

Interest-only can serve as a good alternative to the typical mortgage for the short-term buyer. For example, buy a house in a growing neighborhood where values are likely to increase can lead to a healthy profit on resale, while keeping monthly payments within budget. As property values increase generally, the short-term buyer can use the savings for other investments and still come out ahead with an interest-only loan.

Those buyers who choose interest only for the long term are typically people who expect their future incomes to rise dramatically and want to buy a big house sooner rather than later. They can also appeal to borrowers with a cyclical income (frequently based on periodic commissions or sizeable annual bonuses), who are able to pay off the principal in big chunks.
Lenders know many homebuyers find interest-only loans appealing, with continued high housing prices, especially on the East and West Coasts, and relatively low interest rates. However, Parker|Scheer real estate lawyers strongly advise clients to consult with both knowledgeable mortgage bankers and a real estate attorney to learn more about how you can take advantage of the interest-only loan, and learn about the several risks.

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Contact a Real Estate Lawyer in Boston, MA

For more information on interest only mortgages, or if you need a real estate lawyer in Massachusetts, please contact Rob D. Stewart. If you prefer, you can also telephone our offices in Boston seven days a week at toll free 866-414-0400.

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