Interest only Mortgages

[JHZR2]

Hi,

I am going to be buying a house within the next 2 years. This is a goal Ive set for myself. The area will be the SW part of NJ (A suburb of Philadelphia). I work in Phila., am from north NJ originally, and plan to remain in NJ forever. Ive been priced out of my hometown and the neighboring areas, but really like my job and think I want to stay in my area.

Im waiting for the right place to come along, have my finances in order (meaning a large downpayment), etc. (I have no debt except a modest car payment on a brand new SAAB, which I own much greater than 50% of, and my only expenses are car insurance and utilities).

These "interest only" loans seem tempting. I have to imagine if played correctly, they can be a good way to get started. Of course thats why Im posting here, to get some sense slapped into me

The way I see it is this: As a single guy, with an engineer's salary, high credit score, low age (24), low expenses, and a VERY serious girlfriend (23) getting her doctorate, things are looking up. With nice homes sitting in the ~300k range, its tough to get a 20% downpayment anytime soon, especially since Im maxing out my TSP contributions (14%), saving as much as I can for retirement and everything else, etc.

If I get an interest only loan, the payment on a HUGE amount of money would be quite low, enough that I could have a SUBSTANTIAL amount of free cash each month after paying my loan on a 300k mortgage's interest.

Utilizing an interest only loan essentially equates to renting. However, this is where playing it right comes in. If I dont use the extra money to feed other expenses, but rather to put toward the principal, I can pay off in an amount that is comfortable to me each month, and chip slowly at the amount I owe. There is next to no strain to make the payment each month, and I know that I will be able to pay more than the interest each time. In 7 years (unless I refinance before that), Ill be making more money, Ill be married to someone making a good medical professional's salary (she is getting her doctorate of Physical Therapy), and at BARE MINIMUM will still owe the 2005 valuation of the house.

If home prices stagnate (I cant see them going down, or if they do Im a long-term buyer anyway), Ive lost nothing; Id have been paying rent or something anyway. The worst I could possibly be is sitting on the same amount of debt as the day I closed. Not too bad, considering that Id be getting tax writeoffs on interest, property tax, etc, while paying money for a necessary expense anyway. On top of that, my commute would go from 80 miles each day to about 20 or less, so Id have a lot fo free time, less expenses from driving, and less stress as a result.

So where would I go wrong? I could see if the money 'saved' on an interest only payment goes to unneeded things, other debts, other bills, etc., but if I pay all my available money to interest and principal, Id be chipping away nicely. Even if I did an 80/15/5, and had the interest only and a home equity loan, Id be building 20% equity in the house automatically, paying the 15% HE loan off, not going backwards on the 80% loan, and with all left-over funds, be paying that down too.

So, please give me your knowledge and explain where my reasoning went wrong

Thanks for reading my long post!

 

[GROUCHO MARX]

The first few years of a 30 year mortgage might as well be interest only, hardly anything goes to principal.

 

[XS650]

What is the difference in monthly payments between a 30 year and an interest only loan? Not a bunch is it?

How long it the interest only loan? I think we are heading for some serious inflation and higher interest rates. If you need to refinance in 5 or 10 years, you might have to pay a bunch higher rate.

A 5.25% 30 rate fixed for $300k is $1,656/month
A 5.25% fixed, interest only $300k is $1,313/month

Don't even think about an ARM in todays financial evironment.

You would be better off figuring out how to scrape up the extra $343/month. If you have to make the payments you probably will manage to do it.

[ January 24, 2005, 11:59 PM: Message edited by: XS650 ]

 

[Lance]

As long as you understand you're speculating with your biggest investment, it's OK. I like my investments in assets with greater potential return and liquidity. Also, Robert Kiyosaki (RichDad/PoorDad author)says: Assests feed you, liabilities eat you. Don't be tempted to think of you house as an asset. It costs you, unless you take in enough boarders to cover your monthly.

 

[JHZR2]

According to quicken loans, the typical good credit candidate, which I assume is me, since my score is above 720, etc., etc. is as follows:

For a 300k loan:

30 year mortgage at 6%: $1800/mo
Smart Choice Interest Only: $1050/mo

Adds up to a lot!

terms are 3,5,7 years.

Even if interest rates starrt to climb, they move slow enough that bailig would always be an option. Plus, as a second salary comes into play, more aggressive payments are made, etc., when a real mortgage would be taken, in say, 7 years, hopefully the amount would be significantly less, even if rates were 10%, Id ahve saved some dough and have a smaller mortgage anyhow, to pay off in a shorter term.

Debt (mortgages) are a way of life for the modern person, unless youre super well off. If I got hit with a double digit rate (Id refinance before getting to that point), Id suck it up and deal with it. But, at least I was able to get into something nicer, earlier, and start slowly wittling down the principal at my own leisure while Im on my own, and then really blast away at it when two salaries come into the figure.

 

[JHZR2]

quote:

---

Originally posted by Lance:
As long as you understand you're speculating with your biggest investment, it's OK. I like my investments in assets with greater potential return and liquidity. Also, Robert Kiyosaki (RichDad/PoorDad author)says: Assests feed you, liabilities eat you. Don't be tempted to think of you house as an asset. It costs you, unless you take in enough boarders to cover your monthly.

---

See, but my point, I think, is that Im not speculating. Im playing the available loan resources to my best advantage so that I can get into a better place earlier in time, thus start paying it down quicker, without pressure, and take what may down the line. So long as Im smart about it, and refinance before rates go too high, Id be in good shape.

I dont see how, for example, buying a cheaper home, living in it a few years, then selling and upgrading would put me in any better sort of position... With all the closing costs, realtors fees, etc., etc. At least making one purchase limits all that stuff.

Unless of course Im able to buy a smaller, cheaper home, pay it off quick, then be a landlord. That could pay. However, if real estate keeps going up or at least stagnates, it would take a lot of real estate income to make up for the price increases in my primary home...

 

[Pablo]

Just get a standard loan.

 

[XS650]

quote:

---

Originally posted by JHZR2:
See, but my point, I think, is that Im not speculating. Im playing the available loan resources to my best advantage so that I can get into a better place earlier in time, thus start paying it down quicker, without pressure, and take what may down the line. So long as Im smart about it, and refinance before rates go too high, Id be in good shape.

---

The real problem is that you don't seem to understand that you are speculating. None of us have a clue what interest will be in 3,5 or 7 years when you have to get a real loan. Not having a clue what you are going to be paying on your home loan in a few years is big time speculating with your most importent asset.

 

[Pablo]

Just get a standard loan at the least pts. and lowest rate.

There is no secret. If you can't afford it, then it's too expensive, don't play games unless you are an gambler. Don't gamble unless you are speculator. Don't throw your money away unless you are a rich athelete.

 

[Ugly3]

What is the worst case scenario? Interest rates rise and when you have to roll over the interest only note the payments are unreal. So, you sell the house, only to find that with higher interest rates the housing prices have fallen and you can't get your $$ out of the house.

Think you are speculating?

 

[drive it forever]

Bad idea. The one thing I have as does most anyone who gets a conventional loan is the building of your home equity. I will have my house paid off by the time I am 42 years old. Having a house paid for is the smartest thing you can do to help yourself out when you retire. With this type of loan it sounds as if you might be making house payments forever.

 

[drive it forever]

One thing I cant agree on that alot of "professionals" do is that they get out of college, get a job, and want to get the most expensive house that they can barely afford. I would suggest at your age to get a less expensive house and stay there several years and use the equilty that you will build up for the down payment of your then next house. With living in a less expensive home you can then have some money left over to do things like have a vacation in europe ...

 

[Shannow]

My boss has an interest only loan that he uses to play the stock market...negative gears the interest and therefore has tax advantages.

For a mortgage, I'd personally try to find a place that you like in a price range where you've already got 30% that you can pay up front. i.e. if you've got $30k saved, then aim for $100k house or something like that.

Get a standard mortgage, and then try to make an extra 2 months (plus) payments per year, and as your income rises, don't "invest it" in standard of living, but in increased payments.

When you've paid it off, sit and consolidate for a bit, then move upward if that's what you want.

My brother lost big on his first house, because:
a) he and his wife had not saved a deposit.
b) had a 100% mortgage.
c) paid only the minimum payments, holidaying on the rest.
d) they wanted to make their next big step after two years (keeping up with the Jones'.

Now they've got nearly $600k in mortages (she wanted another house...once again keeping up with the Jones..and they bought a second house)...with looming interest rate rises, no one wants to buy their old (2 years) place.

I like small bites, time to digest, then take another bite if you're still hungry.

 

[Ugly3]

quote:

---

Originally posted by drive it forever:
One thing I cant agree on that alot of "professionals" do is that they get out of college, get a job, and want to get the most expensive house that they can barely afford. I would suggest at your age to get a less expensive house and stay there several years and use the equilty that you will build up for the down payment of your then next house. With living in a less expensive home you can then have some money left over to do things like have a vacation in europe ...

---

You are even more right than you think. Young people make wise financial decisions and sometimes it turns out great on the balance sheet. However, they never took the trip to France that they would have remembered forever as one of the best times but they have a strong balance sheet. Live life, put balance in place, tour the world and live in a smaller house. It works.

 

[JHZR2]

quote:

---

Originally posted by XS650:


The real problem is that you don't seem to understand that you are speculating. None of us have a clue what interest will be in 3,5 or 7 years when you have to get a real loan. Not having a clue what you are going to be paying on your home loan in a few years is big time speculating with your most importent asset.

---

OK, I get your point. My real longing is to reduce turnover. Building equity or not, when all is said and done and one 'upgrades' a lot of money is lost in the transaction. Its at least 6% in realtor fees, new closing costs on the 'upgrade' home, Im sure it will be well over ten thousand dollars, all lost, gone. If I have a 6%/30yr standard loan on 300K, the payment will be about $1,798. If I end up with a 8% 30yr loan on the same 300K, the payment is $2,201. Thats not that much more of a stretch. Plus, if Ive paid some off, then Id have, say an 8% loan on 280k, and then the paument is only $2050. If I can handle $1798 now, when there are two salaries coming into the pot, $2200 won't be an issue. Especially considering that I am currently putting away 14% of my salary to retirement, and could if necessary reduce that.

If I start off in a home that I want, there is no turnover. If it is a home that I could afford a standard loan on currently, then all that Im gaining is the flexibility to not make as large of a payment, so that I can do those sorts of things like take a vacation, etc., without worrying. Once Im married, Ill have at least twice the money coming in each month... Make things easy? Sure! If I could just get by on a conventional loan right now, rates would really have to go up high to make the payment unreachable. And, if in the meantime I have paid off 20% of the value in the house, which is doable, Ill be doing OK.

If in the end, I need to take a new loan at 80, 90% of the home value, so be it. If I see uncomfortably high rates being the standard, say over 7.5%, I could bail into a conventional mortgage. I have no plans to hold any mortgage for 30 years. I have every intention to pay it off in 15 years or less anyway.

But even if I take an 80 or 90% loan a few years down the road, at say, 7.5% or 8%, well, in reality, provided I pay off the home quickly, not over 30 years, I probably come out the same as if I had one home, sold it, bought another, paid all those fees, etc.

The real problem is that there are no $100k homes around in my area. I currently drive 40 miles each way to and from work, and talk about making life not fun... All I do is sit in traffic. Id give up a european vacation to actually have some free time at home at night, not being all stressed by traffic. Unfortunately the best I could do in an area that Id want to live in: not necessarily the fanciest, but a place having decent schools and decent people will end up costing me $200k+. Its just the way it is. I dont want to live somewhere that the schools are lousy, I dont want to live somewhere that is trashy. That to me constitutes a worse investment than to get a place that is expensive but in a better area, so resale will be stronger (people buy for school districts), etc.

Thanks for all the replies, I really enjoy reading them, and appreciate the time youve taken!

[ January 25, 2005, 08:28 AM: Message edited by: JHZR2 ]

 

[Al]

quote:

---

Originally posted by drive it forever:
One thing I cant agree on that alot of "professionals" do is that they get out of college, get a job, and want to get the most expensive house that they can barely afford. I would suggest at your age to get a less expensive house and stay there several years and use the equilty that you will build up for the down payment of your then next house. With living in a less expensive home you can then have some money left over to do things like have a vacation in europe ...

---

I certainly agree. In the best of times (in the 70's when jobs were pleantiful)..I bought a small "starter " house after working 2 1/2 years. Both me and my wife struggled to get it paid off in around 15 years. We led an austere life.

Times now are filled with huge risk. Energy (we are running out), Government Debt (Huge uncertainty), and you living in Jersey (land of high taxes). I think you should "Batten Down the Hatches" and realize that your best laid plains depend on things outside your control. Its good to say that your girlfriend will be bringing in huge bucks. But for now the checks are not rolling in. There is no track record for her as yet-Don't count your chickens before they are hatched. The only thing certain is her school debt (negative) The advantage I had here was my then girlfriend was already graduated and bringing in a paycheck

.

I'm not a risk taker so my advice is conservative-but it worked for me.

 

[JHZR2]

I guess my real frustration, and the attractiveness of the "interest only loan" is the ability to get past a down payment that is very substantial, and still have some flexibility in the beginning.

There are no $100k homes around. A halfway decent $150k home that doesnt need repairs is rare. Sure, if I lived further away, I could surely find them, but thats what Im trying to avoid. Ive spent enough time sitting in traffic jams to realize that my free time reading a book, working out, surfing the net is worth more to me.

Even if I found a $100k home, it would require a $20k downpayment to have a traditional mortgage. Since theyre not really available, lets say a $200k home. That menas I need to scrape up $40k dollars! Even with a decent income coming in, etc., its still a LOT of money to have to save. WHile Im saving it, what am I doing? Living in an apartment? What happens to that money that Im paying each month? Its wasted!

At least if I have a home of my own, the interest is tax-deductible, property taxes are tax deductable (I dont mind paying NJ property tax, since the schools are good, my kids wouldnt have to be bussed everywhere, etc). As I said at the start, an interest only loan equates to little more than renting, but at least I have the tax advantages. Pay anymore than the minimum interest payment, and Im doing better than renting.

Im not trying to argue, just trying to clearly get out what my original thought was... Sometimes its harder than I think, thus all the typing Ive done. Im not trying to make it sound like I know it all or have it all figured out - otherwise I wouldnt be coming here. But, I suppose, just as we have learned about oil, there are many ways to get good results, and 'conventional' often gives darn good results with low downside, but it isnt always better. But alternative 'synthesized' means of doing things dont always prove cost effective or show any benefit either, and can often lead to just throwing away money. But sometimes they do prove to be superior, and therefore warrant consideration!

Thanks again for the advice!


[ January 25, 2005, 08:51 AM: Message edited by: JHZR2 ]

 

[Amkeer]

Does not make sense to take an interest only loan out on a home. Interest rates are low already so why not take advantage of a 15, 20 or 25 year note instead.

 

[Matt_S]

The way I see it, there's one good use for an interest only loan: you won't be living there past the term of the interest-only portion of the loan. In that case, you won't see significant reduction in principal anyway, so you might as well take the lower payment for a while and just hope for some appreciation in the house's value. IMO, if you're planning to stay there a while, you're better off getting a conventional loan for an amount where you can comfortably afford the payments.

Also, keep in mind what the payments on the interest only will be once you get past the initial phase. It could be pretty shocking. Even with your potential future wife's salary, it could be more than you're willing to swallow. I'd examine the options in terms of total long-term cost. The banks aren't in the business of giving away money. It might seem that you're getting a good deal, but be assured that the bank's getting a healthy profit, too. I don't think you'll save money in the long run with an interest-only loan.

 

[msparks]

quote:

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Originally posted by JHZR2:

Debt (mortgages) are a way of life for the modern person, unless youre super well off. JMH

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This is only becuase it's the way people think. I feel that if folks start changing the way they look at it. There would be no need for ANY debt.