Could you handle an Interest Only Mortgage Refinance?

This is our most popular mortgage product today. How would you like a mortgage that either significantly lowered your monthly payment or allowed you to buy a lot more house?

An interest-only mortgage refinance can do either, and lenders increasingly are touting them as the answer to many borrowers' prayers. Whether these loans turn out to be a blessing or a curse, though, depends a lot on who's doing the borrowing:

• If you're a disciplined investor, good with money, a bit of a risk-taker and not buying more house than you can handle, an interest-only mortgage could work for you.

• If you're not all of those things, you probably want to stick to a more plain-vanilla mortgage.

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The catch

Most mortgages require that you pay back some principal with each payment -- a little bit at first, a lot more as time passes. Interest-only mortgage refinance loans skip that requirement in the early years of the loan so that none of your payment goes toward paying down principal. The result is a significantly smaller initial mortgage payment compared with other options, such as a 30-year fixed-rate mortgage or a hybrid loan whose rate is fixed for the first five years:

Like regular mortgages, interest-only mortgage loans come in many different forms. The interest rate can adjust annually or be fixed for a while (usually five, seven or 10 years) before becoming variable. The interest-only portion may end after the fixed period, or it may continue for a few more years before principal payments are required. As with other adjustable-rate mortgages, there are typically caps that determine how much your interest rate can rise each year and during the life of the loan.

Here's how it might work for a five-year, interest-only mortgage loan:

• Your payments would be fixed for the first five years at a certain interest rate -- say, 3.875%.

• For the next five years, you still might pay just interest on the mortgage loan, but the rate would be variable and could increase by two percentage points every six months, up to a cap of 9.875%.

• In the 11th year, the rate remains variable, but the mortgage loan requires you make both principal and interest payments.

Nobody can accurately predict future interest rates. But this is an example of what you might pay on a $500,000 mortgage if the rate started at 3.875% and jumped three percentage points in the sixth and eighth years:

How payments can change on an interest-only loan
Years	Rate	Monthly payment
1 to 5	3.88%	$1,615*
6 to 8	6.88%	$2,864*
8 to 10	9.88%	$4,114*
10 to 30	9.88%	$4,783**

As you can see, the monthly cost can climb steeply, especially once you start paying back principal. You could end up paying a lot more each month than if you had stuck with a 30-year, fixed-rate mortgage refinance loan.

Not a long-term proposition

Interest-only mortgage loans make the most sense when you're borrowing a big chunk of money. At smaller loan amounts, the savings might not offset the loans' greater risk.

And interest-only mortgage loans aren't really meant for the long haul. Mortgage Lenders say most borrowers who get them expect to either sell their homes or refinance their mortgage before the interest-only period ends.

Opting for an interest-only mortgage loan now means you're passing up the chance to lock in today's low interest rates. If you wind up owning the home a long time -- say 10 years or more -- you may wish you had opted for that fixed-rate mortgage loan.

Interest-only mortgage loans were popular in the 1920s, when borrowers wanted to free up money for stock investments. The 1929 crash and subsequent foreclosures ended that particular party, but in the decades since then, private banks made interest-only mortgage loans available to their rich clients. These borrowers tended to have plenty of real estate exposure in other investments, were sophisticated about managing the risks and didn't care about building up equity in their homes.

In the past few years, however, spiking real estate prices -- and increasingly risk-tolerant borrowers -- helped spark a revival for mass-marketed interest-only mortgage loans. Wells Fargo introduced its version three years ago, followed by E-Loan and other major lenders. Interest-only mortgage loans currently make up about half of the adjustable-rate mortgages that Loan brokers, or just under one in six loans the online lender makes overall; other lenders report similar surges in interest.

Who chooses interest-only mortgage loans?

Interest-only borrowers, lenders say, come in two basic types:

• The upwardly mobile. These people are stretching to buy more house, since the same payment on an interest-only mortgage will buy about 20% more house. Translated, that means someone who could qualify for a $500,000 house on a traditional 30-year fixed-rate mortgage might be able to land a $600,000 place with an interest-only loan. Many of these folks expect their incomes to rise sharply in a few years, and they want a bigger home now, rather than waiting to trade up.

• The cash-flow crowd. Others want the smaller payment, for whatever reason. They could be investing the difference, or they might be business owners or commissioned salespeople with irregular incomes, said Washington Mutual executive Lenny McNeill. These borrowers want a smaller payment for the lean months, while being able to pay down their principal in big chunks when the money comes in.

It's a strategy that works very well while home prices soar, not so well when markets stall or tank. If you have to sell when prices are down and you haven't built up sufficient equity, you could take a big loss.

You also could find yourself poorer in the long run if you aren't disciplined. Millions of Americans have built up their wealth over the years by paying down their mortgages. If you skip that step and just spend the extra cash instead, your overall net worth will suffer.

The interest-only mortgage loan solution can work for awhile, but eventually most Americans will want to own their own homes -- not just rent them from the bank. It's definitely a short term solution.

Have you heard that commercial about interest-only mortgages...the one where you’re told about what a wonderful benefit it is to have a low, low mortgage payment and all the wonderful tax write-offs you will receive?

Before you decide to buy now and pay later, that is pay “big time” later, take a moment to enlighten yourself a bit more about these so-called “interest only mortgages.” Think about it for a moment. If you just pay the interest on your home, will you ever start paying on principal and will you ever earn any equity into your property?

By definition, a mortgage is a temporary, conditional pledge of property to a creditor as security for performance of an obligation or repayment of a debt. Simplified, that means you borrow money from a financial institution and they essentially buy your house and you pay it back. How can this happen if you’re just paying interest? More accurately, interest-only mortgages are a temporary reprieve for paying off a traditional mortgage. You may actually be prolonging the inevitable and eventually making it even more costly to pay off your mortgage. Interest only mortgages are really a temporary fix. A borrower should really use them to their advantage and make a principle payment so that your monthly mortgage payment will actually decrease.

Far too many people are in debt way over their heads because of interest-only mortgages. They took advantage of attractive offers to buy now and pay later. With an interest only payment you’re keeping the principal at minimum value while continuing to pay interest at 100%. With a more conventional mortgage you’d be slowly dwindling down the total interest amount.

Most interest-only payment schedules are offered on Adjustable Rate Mortgages (ARMs), but they can also be found on a fixed rate mortgage. Interest-only payment periods almost never run for the entire term of the loan which is typically 15 or 30 years. Depending on the terms of your contract, you could be expected to start paying on the principal in five, seven or ten years although most interest only mortgages are interest only for 10 yrs. Once the interest-only period ends, your monthly payment will go up because then you’ll be paying on both principal and interest.

Conversely, interest-only mortgages can be a good thing for some people. For those people wanting to purchase a bigger/better home for a lower down payment AND who anticipate moving within seven years, the interest-only payment method may be the way to go. However, keep in-mind that in a "down" realestate market you generally won’t be building equity and making money by doing it this way. The majority of the money made from investing in real estate comes from an increase in value to the home. The average person moves every seven years anyway. Gone are the days when people stay in a home thirty years. Hence, if you anticipate moving before you’ll have to start paying on the principal, then an interest-only payment may be the ideal choice for you.