Interest only mortage

[Renrel]

My husband has been talking about an interest only mortgage, which if I understand it correctly means that, if you follow the required payment plan, you first pay off the intrest and then pay off the principle, so that if you are paying the amount you are required to you are not gaining any equity. But he says that we can pay above and beyond the interest due and that anything extra would go towards the principle and thus we would start gaining equity if we chose to and that would be our plan.

He gave me several reasons for doing our mortage this way.

1) He said that if you pay extra on a regular mortage the bank just holds onto your money and does not apply it to the loan until the very end, so that there is no real benefit to you. You pay off the loan faster but you lose the use of your money for all those years without decreasing your intrest payments at all, or something like that.

2) The loan payments are less and if we have to sell in the short term, say under 5 years, he says it is a better deal. This is a possiblity for us.

3) If we have a short term financial issue we can choose to pay the interest only amount which is due and not the extra in our plan until that issue resolves. Such as my going on materity leave or DH being out of work for a short period of time.

4) I believe he said we could afford a larger mortgage using this type but I am not sure about that.

Anyone know anything about these kinds of mortages? Any reason to do it or not do it this way?

[MrsBeckyLP]

I don't know anything about them, and I'm going to be absolutely no help. BUT ... I do know that I've only heard bad things about them. I can't even give you an example, but I've heard way too many people say it's just not a good idea or something you want to get yourself into.

[hmbay]

This article hits most of the pros and cons:

http://www.washingtonpost.com/wp-dyn/content/article/2005/05/28/AR2005052800185.html

Also in light of all the sub-prime lending fallout lately and foreclosures I'm not even sure lenders are pushing this option anymore as alot of people who went for this type of loan were people who couldn't afford the house they really wanted and once the principle payment kicked in they ended up losing the house.

And far as I know none of the 5 mortgages I've had over the years worked like your point 1--if I paid extra it affected the interest over the life of the loan immediately at payment but I'm not saying all mortgages are written that way--you'd have to check your financial paperwork to see what type of mortgage you currently have.

[Sadie]

We looked at this as an option when we bought our house 3 months ago, but went the conventional route instead. Here are a couple of articles that give more in-depth information:

http://library.hsh.com/?row_id=58
http://www.usatoday.com/money/perfi/columnist/block/2004-06-28-mortgage_x.htm

Basically, I think the benefits of the loan are greatest to those who are taking out very large loans (and plan to invest the money they would have spent on principal each month). Otherwise, it doesn't really end up saving you much.

However, I'm no financial wizard, so I'm sure someone else will have better advice to offer!

[thedoorchick]

1. I've never heard the concept described that particular way. I suppose what he's saying is true, but it's missing the point. No, extra payment towards principal of a loan will not reduce the monthly payment, but it does reduce the principal. Either you will pay off the loan sooner or you will have less to pay off when you sell, whichever comes first. Either way, a good thing to do, though you want to consider the tax implications. With rates being what they have been in recent years and considering the tax deduction, you're often better off paying off other debt and/or investing your extra money, than paying down the mortgage.

2. The loan payments will be less, but you'll be paying off no principal, and I don't consider that an advantage. That being said, in the early years of a loan, obviously less principal is paid even with more conventional loans.

3. This may be true, but a better option is to maintain a cash reserve and rely on that for emergency funding.

4. I would suspect that any interest-only loan would enable someone to buy more house than they would otherwise. The question is, can you afford it? There's a big difference in what you can qualify for and what you can afford (I have a whole rant on that directed at lender, but I'll save it for another time).

People do these loans more commonly on the coasts in higher-appreciation areas. I personally would never touch one, but that's me. If the market tanks and you end up upside down, that is not a place I would want to be.

[Pookie]

I don't know a whole lot about this, but the only things I've heard are bad. If a "perk" is being able to afford a larger mortgage, it's probably not something you can really afford to begin with. Lenders are notorious for financing you for much more than is realistic. Also if you have to sell in short term since you have gained no equity, you may not get anything out of the house. If the market goes down and you sell shortly, you've lost money that you wouldn't get back from selling the house. Again this is not something I know alot about it. My DH works with some people who did this is and totally regret it.

[Amuse Bouche]

Interest only loans are a better idea if you live in an area with a consistently rising housing market or you're willing to stay put. As far as I know, the three areas with a consistently rising housing market are NYC, the west side of L.A., and San Francisco city proper. If you have an IO loan and the value in your house drops, because you didn't build any equity with your payments, you may end up owing money when you sell the house. That's really the big risk.

[Loud_curly]

We are looking to sell our place soon, and buy another one. We are considering using an I/O loan, mainly b/c a large chunk of DH's salary is paid in a lump sum bonus. Instead of making higher payments every month, an I/O loan would allow us to make one HUGE prinicpal payment and the rest of the year pay smaller amounts (so on a yearly basis, we'd pay the same amount of prinicipal as a regular amoritzing mortgage). However, we plan on buying a house we could also pay off with a conventional fixed mortgage, so we wouldn't be qualifying for a larger mortgage b/c of the I/O payment. We also plan on this being our "forever house" so being upside down for a little bit wouldn't bother us.

So yes, there are benefits to I/O, but I think you need to be REALLY disciplined to ensure that you pay down principal and not just the interest, ESPECIALLY if you don't plan on staying long.

[nicks]

You are gonna get lots of different opinions on this but here is mine:

I have an interest only mortgage and use it the way you describe in your 1st paragraph. We pay the difference between the interest only payment and the full principal and interest payment every month so that it goes directly towards principal. As others have said in the early years of a mortgage most of your payment goes towards interest, using an interest only loan this way pays down your principal faster.

I would NOT use an interest only mortgage to be able to buy more of a house than you would otherwise be able to afford. Most interest only loans are only interest only for the first 5 or 10 years, after that you need to be able to afford the full payment (if you haven't refinanced before that).

I hope this makes sense, good luck with your decision.

[chinita]

I know that there are lots of cautionary tales out there about I/O loans. But if you do your homework and are disciplined as other mentioned here, I/O loans may be a good option for certain situations. I will share my reasons:

- We don't plan on staying at our new place for longer than the term of the I/O period. This is not our "forever" house.

- We planned our home-buying budget based on my income alone as DH is a graduate student. He will finish his degree soon and we expect more income when he gets a job.

- We also plan to pre-pay some of the principle as well.

- Even though there is a recent "slump" in the market, we still expect home price appreciation in the L.A. area. Maybe not at the incredible rates of 20-50%! We hope that we will still build equity with some prepayments and appreciation.

:rolleyes: OK, I'll be honest and admit to using the I/O loan to afford more house. I think those of us who live on the coasts understand the reality of this. But, I did try to convince myself with the above reasons why we are not committing financial suicide.

[PinkMartini]

chinita I hear ya... I'm up in N. Cali and we can't afford a home here. If my DH wasn't so against I/O loans, we'd probably go that way just to be able to afford to live here... $400k + up for 1500 sq ft is ridiculous. Ca just sucks...

I have only heard negative things about them though. Good points made in this thread by knowledgable ladies :)

Good luck in whatever you decide... We're going on 3 years now of trying to buy our first house so I know how ya feel :(

[tenofcups]

We currently have an interest only mortgage, but our situation is a little different since we actually have our loan from DH's parents. Dh originally had a conventional mortgage with a bank and we changed it to this when I moved in with him. We had several reasons. First, his parents offered, the reasoning being that eventually the money would be ours anyway. :)

But mostly we felt that it made sense at this time since the amount was really quite minimal and we knew that when we sold we will make a substantial profit (even in a declining market, we're currently looking to sell for close to five times what he bought for originally). This allowed us to take our extra cash and put it into required housing renovations as well as get ourselves a little more established financially since we had both been through several life changes right before we moved in together.

So really our situation is the opposite of what some others described -- we felt it made sense for us not because the loan would have been larger than we could afford but actually because it was a lot smaller than what we could afford so when we sell, we'll still get a large sum of cash to go towards the next house even though we haven't paid anything off on this house.

I'm not certain if we'll do the same kind of loan for our next house or not. I suspect we will, but make more of a concerted effort to pay off extra each month.

The downside, of course, is that even though we pay every month, we have not reduced our debt.

[Rose]

For the most part I don't think they are a good idea.


2) The loan payments are less and if we have to sell in the short term, say under 5 years, he says it is a better deal. This is a possiblity for us.

Another way to look at it is if you have to sell you haven't paid down any of your principal and if the market is bad then you may take a loss.

[jonesygrl]

Being another gal from California, we did a IO as well. And and I have to agree with Chinita for the reasons why. I think if you are financially disciplined, not in your forever home, not in debt in other areas of your life, then I don't understand why they are so bad. Here were our main reasons for doing IO:

1. We are not in our forever home and will be selling before our IO turns into interest + principal (5.5 yrs left on our 7yr). Or we will refinanced and possibly even done IO again.

2. We are using our available funds to do lots of work to our very old house, which even if the market is not up to where it was when we bought it in 5.5 yrs; hopefully the work we do will boost it up and we won't sell for a loss.

Also, from what I understand, the first few yrs of a "traditional" loan you're paying mostly interest anyways, so what's the big difference?

[pixielou]

how do interest rates compare on an i/o vs a conventional 30 year? i guess i could look this up, but i never considered i/o as an option for my mortgage.

the 2 reasons i've always heard that make sense for an i/o don't seem to necessarily apply in your situation

1) you are in an area of rapid housing appreciation and you plan on selling in less than 5 years. this sounds like a maybe for you - as opposed to a definite? if you had to sell in a few years and were upside down on the house, do you have the cash reserves to pay the difference, plus get you in a new house? we have a friend who was a bigwig at ge - ge moved him every few years and paid all his relo costs - including re commissions - so he always did the i/o. he claimed that knowing his re fees would be covered was a key factor - less likely that he woulld be upside down on the house. as soon as he took a "permanent job" in fl - he went straight to the standard 30 year.

2) the i/o mortgage makes sense if you know your income will be substantially higher in a few years - like if you are in grad school, med school, law school. though in your case it sounds like you are looking at your income declining in a few years?

good luck in your decision. we are also in the boston area and it took us well over a year to find a house.

~pixie

[Asha]

i thought a lot of interest only loans had rules about prepayment of the principle. a lot of you are mentioning that you plan on prepaying the principle anyways. i am confused.

[Wrighty26]

I live in FL where the housing market just BOOMED a few years ago (houses were literally doubling in price), and so we also went the IO route with our main ((80%) loan. We were initially very nervous about doing it only because we did foresee a change in the market/rates in the next few years, but the pros outweighed the cons in the end. Just in the year that we closed on the house (and the 2 years that we went under contract -- we built) our salaries have increased roughly 25%, so I now feel confident that we will have the money to support a mortgage increase (although, I believe we are either going to move or refinance).

I think that any real-estate investment with ANY loan is a risk - you just have to work out which risk works out best for you.

[Wrighty26]

i thought a lot of interest only loans had rules about prepayment of the principle. a lot of you are mentioning that you plan on prepaying the principle anyways. i am confused.

This can vary depending on the loan. My loan does not have any penalties for paying against the principle.

[andrew&shannah]

We have an IO loan. For us, we used it as a way to qualify for the house we wanted on my DH's income alone. Had we considered my income, we would have easily have been able to buy a much larger home but we didn't want to go that route. In addition to that main reason, we also considered:
1) We live in the DC metro area. While not as crazy as some places (NY and CA), housing prices here do tend to continually increase. I think our county is considered the fastest growing county in the state.

2) We do not plan to live in this house for more than 5 years. We know this is definitely not our forever home and will sell before the IO period is over.

3) We had already factored paying additional principal into our budget for a mortgage payment. Each month, we pay the difference between a traditional 30 year fixed and our IO directly to the principal. In our case, this actually works better for us with regards to selling because, with a traditional fixed loan, most of that money would go to interest and we are paying it directly onto the principal. Oh, and we have no penalties for pre-payments. I would avoid an IO that does.

[jajacobsen]

I am a CPA with 20 years of professional experience. I also hold an MBA. Specific areas of my expertise are in the banking and mortgage loan industry.

Interest-only loans became very popular about ten years ago. Some are true "interest only" loans in which the borrower tuly only repays interest never repays principle. Others have an interest-only period at inception, an dthen convert to a more standard debt-amortization mortgage at some point (usually 5-7 years).

Interest only loans may be approriate when any of these conditions exist. If several of the following conditions exist, then an interest only-loan may be especially appropriate.

1) The market value of the property is increasing so therefore equity is created by the market appreciation rather than debt reduction.

While certain anomalies exist, I will note that economic forecasts for the US predict tha the real estate market will remain stagnant or actually drop over the next 24 months, with some recovery within 36 months. 2008 is expected to be the bottom here in the Southeast (Florida excluded, which has already experienced significant declines in market value and may start to recover sooner). I would expect California to follow the trend of Florida. The market recovery in the affected areas of the Northeast is estimated to take longer. The rest of the country is in a slump, but did nto experience as dramatic peaks and troughs.

2) The salary of the borrower is expected to increase substantially within the next few years, allowing the borrower to buy TODAY the house they would otherwise be able to afford in a few years. Usually the borrower refinances to a conventional mortgage when their salary increases.

Professions that come to mind where these mortgages are common are attorneys and doctors, due to the large potential for increasing income.

3) In certain cases, since interest is tax-deductibel and rent is not, it may be advantageous to do an interest only-loan as opposed to renting. Note, all other potential itemized deductions, must be considered along with the loss of the standard deduction and what available rental costs would be.

4) The borower has an "emergency fund" of cash set aside and is able to find other sources of credit, because there will be no home equity to tap into in the event that large amounts of cash are needed. Additionally, it is helpful if the borrower is not at or approaching their total borrowing capacity.

5) Interest rates are expected to drop within a few years, making it possible to refinance the home under a debt-amortization mortgage and keep the payment within an affordable range. Currently, interest rates are NOT exected to drop within the next few years.

6) The borrower is knowledgeable and is able to make informed choices between various types of mortgages.


I'm going to insert comments within the body of renrel's initial post, because I want to speak directly to her points.

My husband has been talking about an interest only mortgage, which if I understand it correctly means that, if you follow the required payment plan, you first pay off the intrest and then pay off the principle, so that if you are paying the amount you are required to you are not gaining any equity. But he says that we can pay above and beyond the interest due and that anything extra would go towards the principle and thus we would start gaining equity if we chose to and that would be our plan. This is true, but the same would apply to any mortgage.

He gave me several reasons for doing our mortage this way.

1) He said that if you pay extra on a regular mortage the bank just holds onto your money and does not apply it to the loan until the very end, so that there is no real benefit to you. You pay off the loan faster but you lose the use of your money for all those years without decreasing your intrest payments at all, or something like that.

This is completely not true. Additional payments of principal are applied to the mortgage's outstanding balance in the period they are received, therefore reducing the outstanding balance and the interest owed on the mortgage. While the mortgage company will not re-do the payment plan for these additional payments (as in the borrower must continue to make the monthly payments according to the original payment plan), the outstanding balance and accruing interest is reduced. So each additional payment made applies a larger portion to principal and less to inetrest, because less interest is owed because less devbt was outstanding due to teh extra payments. The payoff value will be lowered, not just by the additional principal payment made, but teh additional amount of each subsequent, regularly scheduled payment which would have gone to interest but was applied to principal because less interest was due in the subsequent months (becaue you paid down the debt with extra payments so you owed less debt and owed less interest on that debt).


2) The loan payments are less and if we have to sell in the short term, say under 5 years, he says it is a better deal. This is a possiblity for us.

The loan payments will likely be less. However, they may not be substantially less because in a debt-amortiztion mortgage, most of the payments in the first five years are substantially interest. The primary factor in determining whether or not selling within five years it is a good deal is the expected market appreciation, due to the transacion costs of teh sale and subsequent laon. By transaction costs I mean realtor fees and mortgage origination and loan closing costs. You will need to feel certain that you will make enough off your home in profit to pay these costs and have some additional profit to roll into your next hoem as a down payment..

3) If we have a short term financial issue we can choose to pay the interest only amount which is due and not the extra in our plan until that issue resolves. Such as my going on materity leave or DH being out of work for a short period of time.

This is true, which is both a benefit and a danger in these etypes of plans. The benefit is that you have flexibility to skip an additional payment if you are short on cash. The danger is that it is all too easy to always be short on cash and never get around to aking additiona payments.

4) I believe he said we could afford a larger mortgage using this type but I am not sure about that.

Usually this is true. However, I would ask your mortgage broker to prepare two "good faith estimates," one being an interest only loan and the second being a conventional 30 year loan. Look at the differences carefully.
Anyone know anything about these kinds of mortages? Any reason to do it or not do it this way?

It may seem that I am negative about interest only loans. Actually, I am not. But I do not USUALLY think they are appropriate for firts time home buyers in the current economic forecast (declining housing market and rising nterest rates). The high rate of defaults and foreclosures recently associated with these loans supports my view.

For all of posters who have interest only loans, please do not take offense. They may be working for you as it may work for Renral and her husband. But they should consider the factors I have listed above, aong other things.

Renral - good luck!

[mamax2]

You've received a lot of very detailed and thorough info., esp. from jajacobsen so I'll just give my personal experience w/I/O loans.

I'm on my 4th or 5th I/O loan. We use them routinely when buying property - both improved and unimproved. We use them specifically to give us a lower interest rate, therefore lower monthly payment. We do NOT use this method so we can afford more property, we use it so we can pay more towards principal (and some other extenuating circumstances re: business loans, etc.) Anyway, it has so far always worked in our favor. The properties have all been in East Coast states and we ALWAYS make a substantial payment towards our principal every.single.month. We will, obviously, re-fi along the way if another loan situation becomes more advantageous.

[udsweetpea]

Everyone else has given you great advice. I also wanted to add that I/O loans do come with a slightly higher interest rate.

[PinkMartini]

We use them specifically to give us a lower interest rate, therefore lower monthly payment.

I also wanted to add that I/O loans do come with a slightly higher interest rate.

:confused: Do the interest rates differ between the different I/O loan types??

[udsweetpea]

The lenders I work for offer higher rates for interest-only because they're more of a risk for the lender.

ETA- It is a higher rate but you do get a lower payment because you're only paying interest. There are also 40-year loans out there with a 10 year I/O period, and those have an even higher rate with them.

[Wrighty26]

Everyone else has given you great advice. I also wanted to add that I/O loans do come with a slightly higher interest rate.

Hmmm...we got a lower rate with our IO loan (for the first 5 years at least). I don't think this is ALWAYS true.

[udsweetpea]

I just looked over our 11 page rate sheet, and all of the I/O programs have a hit to the rate.

[jajacobsen]

mamaX2 - from what I know of you from CC, you are exactly the type of borrower for whom IO loans are most appropriate: knowledageable and experienced about the mortgage loan business; buys properties which you often improve so can be confident about equity appreciation; and disciplined to make additional, non-required principal payments along the way.

udsweetpea and wrighty: When tehy first came out, IO loans often bore comparable or even lower interest rates. Now I find the interest rates are the same or slightly higher than 30 year mortgages. There has definitely been a shift in the lending climate.

pinkmartini - yes, there are definitely differences in rates. By law, Each lender sets their rates independently, and may charge different rates between the various types of loans they offer.

I think the main reason I wanted to respondto the OP was to correct the mistaken belief that "if you pay extra on a regular mortage the bank just holds onto your money and does not apply it to the loan until the very end, so that there is no real benefit to you. You pay off the loan faster but you lose the use of your money for all those years without decreasing your intrest payments at all, or something like that." I am not picking on the OP at al - this is not an uncommon misbelief but it is so untrue!

For this reason, I do not beleive the spouse or the OP fit the criteria or being knowledgable borrowers and can make informed decisions between the various types of mortgages. That does not mean they cannot gain the knowledge, within a very short time frame (thsi stuff is NOT rocket science!), but right now I would advise they do some homework and any reputable mortgage lender should suggest the same. That's all. It may turn out that an IO loan fits their lifestyle and financial goals very well. However, in the cuerent economic climate, I caution them to consider all factors very carefully.

[Renrel]

Thank you all for your informative posts. I need to read through them all and figure out what the mean. I am a novice when it comes to finance stuff and tend to tune out when people start talking about. I know that I should not but it is an effort to stay focused and if I am tired or distracted by anything else I just drift out. I may very well have misunderstood what DH was saying about the mortages. I assume he understands what they are about since he has a MBA from a high profile school that specializes in finance stuff, but he may still have misunderstood something that he was told by someone. I want to gain a better understanding so I can give informed input into this decision and relieve him of some of the responsiblity. FWIW It is our intention to purchase a home that needs some work and increase its value. We are planning our budget of what we can afford around mortage payments which included more than the required interest, not with the idea of paying more when we can. We also are not looking for a home that makes use house poor. There must be money left over for retirement, college education, and to live. We have no other debt at this time. All car and education loans are paid off. Credit cards are paid off as well. But that may still not mean that we are the best candidates for this kind of a loan.

[jajacobsen]

Renrell - Good luck! It sounds like you & your DH are well set up financially to take on a mortgage - type TBD. Please feel free to post questions here or PM me if you prefer. I'm not an expert compared to many, but I can give you some basic information.

[diam124]

I am not terribly knowledgeable about loans and such (DH is though). We bought a townhouse 1.5 years ago after he finished grad school. Our main loan is interest only. The reasons we went with it were:

1) DH was just getting out of school and we were moving to a new area. I did not yet have a job in the new area. DH's salary was difficult to predict as he has the ability to collect a 40% annual performance-based bonus. We bought our house knowing that it was at the upper end of what we were comfortable with spending if I did not work and based on DH's salary without any bonus. The interest-only mortgage allowed us to keep our payments a little lower based on that.

2) We were moving to an area of the east coast that had a huge jump in housing prices. So we were comfortable knowing that the value of our house would increase.

3) We pretty much knew that we would be outgrowing the house and/or wanting to move elsewhere in the 5 year time range. This is our starter house.

[Brady]

We are also in an I/O loan. We did this as I am SAHM, and my DH work alot during one season, and not alot during another. This way if we HAD to, we knew we could just pay the interest, which we could afford without overtime, etc. on his part. That said- we put down 20%, have always paid more than the interest for the most part to apply to the principal, there were two months that we did have to just pay the interest, but then just applied double to our principal when his overtime kicked back in. Like others have said, you have to be disciplined to take on this type of loan, but it gives us that little peace of mind due to my DH's profession. We figure when we pay down a certain amount of principal, we'll refinance, and for sure will refinance before the introductory period of interest only ends (7 years in our case)

Re: interest rates. We were quoted the same rate with our I/O or fixed rate.

[laura]

Can someone dumb this down for me? What is the benefit of an interest only loan? Let's assume interest rates for 30y fixed are comparable - why NOT go with fixed? Our mortgage brokers are pushing interest only and I just frankly do not get the benefit to the purchaser. Plus, if we do 10 years interest only, what happens at the end of the 10 years if we still want to live in the home (though I don't think we will, but still - for argument's sake)? Don't we just re-finance the entire principal at a higher interest rate and end up paying more in the long run? So the rest of the interest we paid the first 10 years is like tax-deductible rent?

TIA!

[udsweetpea]

The benefit of having an interest only mortgage is a lower mortgage payment. At the end of the first 10 years, the balance is amortized over 20 years at the same interest rate. When you refinance, why would you be refinancing at a higher interest rate?

[jajacobsen]

Becasue rates are increasing now and expected to continue to increase over te next five years. Rates are very very low now, historically, even though they have risen slightly over teh past three years.

[udsweetpea]

Rates have actually been decreasing for the last month and will continue to get better over the summer.

[jajacobsen]

udsweatpea - that's a pretty short term window. It would be foolish to base your mortgage decision on such. Basically you are using a very small window of time to refute long term economic forecasts by well respected economists predict interest rates to rise over the next five years. Persons are encouraged to lock their interest rates now, if at all possible.

But then, possibly I don't know anything about what I am talking about. After all, I only locked a 15 years mortgage at 5.25% (no points) on a home where I have 70% equity. Clearly I am bad with money.

And FWIW, I had a standard amortization mortgage on my first house and between the scehduled and additional payments, plus market appreciation, I pulled a clear $125k out when I sold after just 5 years. I did no capital improvements to that house. Even just paying an additional $100-200 per month every month in the early years really does make a huge difference over time.

Forgive me - that was grouchy. But honestly, look in any rate forecast and they wil be going up over the next five years. In referring to the IO mortgage above, you spoke about refinancing after tenm years. So what rates have doen this month or wil do over teh next 45-90 days is erally irrelevant. Rates are historically quite low now. Common sence says tehy will likely not remain that low. The last time rates were as low as they aretoady was in the 1970s So it is smarter to lock a rate now. Possibly you are two young to remember teh 1980s, but rates on mortgages were in the 12-18% range. Smart money says lock now.

[larslobster]

laura - they are probably pushing the i/o loan figuring you'll NEED to borrow every penny you can because of the high cost of housing in the bay area. However, when rates are this low (and they are still historically very low), it doesn't make sense to take on that kind of loan with the intention of refinancing in a few years since rates will most likely be higher by then.

I'd definitely listen to jajacobsen. She really knows what she's talking about.

[udsweetpea]

udsweatpea - that's a pretty short term window.

I was responding to your comment of "Interest rates are increasing now", which they have not been.

[jajacobsen]

I was responding to your comment of "Interest rates are increasing now", which they have not been.

But they are! Maybe not in the last 30 days, but overall, they have been. Rights are slightly higher now than tehy were last year, and even slightly higher than three years ago. Three years ago One coudl lock a mortgage soemwhere between 4-5%. No way are those rates available now. Note: When I quote rates, I use a 30 fixed mortgage rate as the benchmark to explain trends. ARMs and Io mortgages may have lower rates. However, teh trend s all work teh same. Up is up.

Think about the cost of money (interest rates) like the cost of gas. Is gas higher priced today than three years ago? Yes. Than ten years ago? Yes. Is gas expected to continue to rise in price? Yes.

For purposes ogf thsi analogy, let us assume taht gas currently costs $3/gallon.

So, if you could have locked in your price on gas, ten years ago (suppose gas was $1.50 a gal then), for the next 30 years, would that have been a smart move? Yes. And even if after you locked in your price of gas ten years ago, if the next month, or even the next year, the price of gas dipped somewhat (to say $1.40/gallon), in hindsight, would it still have been a smart move to lock that gas price? Yes. Because even if you paid slightly higher than market for a short time (9-9.5 years ago), today you would still be winning big time! Because you would be guranteed to buy your call at $1.50/gallon when all the rest of us have to pay $3/gallon.

Mortgage rates work very similarly, except they don't always increase. In fact, sometimes they go way, way down. For example, as I referenced beore, in the 1980s, 12-18% was not uncommon. Many people had ARMs and were losing their houses big time. However, my parents had a 30 years fixrd on our home they bought in 1969 at 4.75%. They were so happy they had a fixed rate!

Rates are low. If you have someleeway in locking you rate over teh next 30-90 days, it may pay to play the martket to gain a quarter point or so. Thsi may have been what Udsweetpea was referring to.

However, if you are deating IO, ARM or fixed rate mortgages, you must ask yourself However, if you are debating whether to get a fixed rate now, you must have a very frank discussion with yourself or with your spouse as to teh maximum amount of time you may possibly be in the house.

If you want to do an IO or ARM now with a low initial rate and then lock in a fixed rate 5-10 years from now, I cannot advi se that at all unless you are certain you will be selling that home within 5 years max.* Rates will NOT be lower 5-10 years from now. So if you plan to be in your home more than 5 years, most economists would advise locking teh rate now.

If you are CERTAIN you will sell teh home in less than 5 years, an initial low rate may work for you. That is because when you sel teh hosue and buy a new one, you will have to accept whatever the rate is then when you buy your next house. So you migth as well take advantage of the lowest rate available now.

[jajacobsen]

laura - they are probably pushing the i/o loan figuring you'll NEED to borrow every penny you can because of the high cost of housing in the bay area. However, when rates are this low (and they are still historically very low), it doesn't make sense to take on that kind of loan with the intention of refinancing in a few years since rates will most likely be higher by then.

I'd definitely listen to jajacobsen. She really knows what she's talking about.

blushes - thanks. I am no expert. I just happened to see a lot of my friends lose their homes when I was a teenager due to spiraling interest rates on ARMS (those nasty 12-18% rates I was referring to). Not all went into forclosure, some were distress sales just to get out of a mortgage. The parenst then bought a cheaper, (usually smaller or not as nice house) which would have a lower payment, even at teh hight rates. What a way to lose equity!

That illustrated a very important economic lesson to me as my family was poor my any standards, yet we were secure in our home. One of the few wise financial things my dad ever did was get a 30 year fixed at 4.75%.

I am not against IOs or ARMs, but I think the borrrower needs to be very aware of the risks. My forst home (the one I refererd to above that I pulled a lot of equity out of upon sale) was on a 7 year arm at 5.78%. Marhet rates for 30 year fixed mortgages at that time were in the high 6s-7s. I was very certain this was my starter home and i would nto be there more than 7 years. I was there for 5. And so I got the benefit of that great rate for 5 years. But, it was a risk. You have to be certain you will be moving before teh low, teaser rate expires.

[laura]

Great, thanks - that is very helpful. Increasing rates are actually my concern, even though I am as sure as one can be about anything that we will not remain in this place for 10 years, and probably less than 5. But still - I worry.

And yes, what jajacobsen said about interest rates is my concern. Of course I wouldn't CHOOSE to refinance at a higher rate, but I recognize the very real possibility that I may have no other choice in 5 or 10 years.

The weird thing is that we have 20% down and our mortgage brokers know this. I understand pushing IO on ppl w/ very little cash to put down, but I was just surprised in our case. But I think it must be b/c we told them it's a short-ish term house for us, not our 'forever' place.

[udsweetpea]

IMO, I'd get a fixed rate and not an IO if its a short-term house. That way, you're building more equity in the short time you're there, even though most of your first payments go mainly towards interest anyway.

[mamax2]

IMO, I'd get a fixed rate and not an IO if its a short-term house. That way, you're building more equity in the short time you're there, even though most of your first payments go mainly towards interest anyway.
You're only building more equity w/a fixed mortgage *if* you put NO add'l payment towards principal w/your IO loan. If it's a short-term ownership situation and you can and will put money towards principal, then you're still building equity. An IO loan can offer some buyers a low enough rate to open up their cash flow and allow them to put more towards principal. Again, as jajacobsen has illustrated, it's not for everyone, but it is a legitimate strategy for a savvy consumer.

Again, I'm by no means a mortgage expert. I have had multiple IO loans and we've worked them to be financially advantageous every single time. It's not for everyone, but it works in the right situation.

[laura]

Thanks for the feedback, everyone. We decided to go w/ the 10 yr IO loan for a variety of reasons, although at the time we locked, the same rate was offered on a 30 yr fixed. We plan to pay the full amortized (?) payment anyway, not just the interest, but we like that there is slight flexibility if we ever needed to pay less.