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BY DAN RAFTER | Saturday, March 26, 2005 | (No comments posted.)
Interest-only mortgage loans are soaring in popularity across much of the country. Borrowers in Northwest Indiana and Chicago's south suburbs, though, haven't yet flocked to these new mortgage products that can provide home buyers with a significantly lower monthly mortgage payment.
The question is, should more local buyers seek these loans?
The answer, not surprisingly, is complicated. Local mortgage pros say it all depends on the borrower. While an interest-only loan is perfect for some home buyers -- notably those who are paid large sums of money on an irregular schedule -- they may not be the best option for others. The only way for a home buyer to know if an interest-only loan makes sense is to consult a mortgage loan officer familiar with the product.
"An interest-only loan does come with a reduced mortgage payment, and that's what attracts a lot of people to it,'' said Rich Serletic, one of the owners of Mortgage Professional Group, a mortgage brokerage located in Valparaiso. "But these loans are not for everyone. This loan would be the wrong one for some people."
The basics
Interest-only loans are popular these days, especially in bigger markets such as Chicago. The reason is simple: They offer low monthly mortgage payments. LoanPerformance, a firm that studies mortgage trends, says that in 2004 nearly one-third of home mortgages were interest-only loans.
Here's how such loans work: Borrowers who assume interest-only loans initially pay down only the interest on their loans when they make their monthly mortgage payments. This arrangement lasts for a set period of time, usually five to seven years. After that period ends borrowers can either refinance their loan into a different form -- perhaps a standard 30-year fixed-rate loan -- pay the loan balance in a lump sump, or start paying off the principal on their existing loan. The problem with the last option is monthly payments suddenly jump. Not surprisingly, most homeowners choose the refinancing option.
Because of the way interest-only loans work, mortgage consultants recommend them for only a certain kind of borrower. Borrowers whose income mostly comes from irregularly scheduled commissions or bonuses, those who expect to earn a much larger salary in just a few years and those who are skilled enough investors to make wise use of the money they will save by making smaller monthly mortgage payments are good candidates.
Borrowers who have a standard pay schedule from their employer and are not experienced investors probably should look toward another loan product, financial experts say. And with the wide variety of mortgage loans now available -- everything from loans that require no down payments to those that provide significant discounts to the owners of energy-efficient homes -- borrowers should have no problem finding an alternative if an interest-only loan isn't right for them.
"These loans can become dangerous tools when borrowers use them to qualify for a loan or to get into a home that they otherwise could not afford. And, unfortunately, we are seeing a lot of that taking place," said Greg McBride, senior financial analyst with Bankrate.com, an online financial news source. "They make the most sense for borrowers that could otherwise afford a fully amortized loan payment, but instead prefer interest-only because it allows them to maximize their other investment opportunities."
The theory behind interest-only loans is borrowers will take the money they are saving from their smaller mortgage payments and then invest those dollars. After five to seven years, those savings, if invested properly, can pay off big.
The local market
Borrowers in Northwest Indiana and Chicago's south suburbs have not yet flocked to interest-only mortgages. That's not surprising. These loans are most popular in large metropolitan areas where home prices have soared. By turning to interest-only loans, and their lower monthly payments, buyers in these parts of the country can get into homes that they otherwise could not afford.
Fortunately for buyers here housing prices have increased steadily but are still affordable when compared to markets such as Chicago, New York City and many areas in California.
"These loans are not hot here right now," said Peter Bakas, office manager at First American Home Loan in Merrillville. "People need to learn about them. They need to read more about them, see more about them on TV before they become popular. We have a branch office in downtown Chicago, though, and there the loans are really picking up in popularity."
Doug Duncan, chief economist and senior vice president of the Mortgage Bankers Association of America, has pointed to interest-only loans as one of fastest-growing mortgage products among consumers.
"These loans are especially interesting, and extremely popular these days," Duncan said. "They are attractive to people who are stretching to get into a house. The question you have to ask if you are interested in one of these loans is, 'Will my income levels probably grow in the future?' If the answer is 'yes,' then there is probably no risk for you to take out an interest-only loan."
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