Interest Only ARMS

- Talk of the Town but Not for the Uninformed -

OAK BROOK, IL, Summer, 2005 -- Home buyers are bombarded daily with promises of unrealistic financing options.  Lenders often lure buyers with claims of huge loan amounts for ridiculously small monthly payments and impossibly low interest rates.  For the unsuspecting buyer, those empty promises can spell financial disaster.

In the worst situations, borrowers mortgage a new home purchase, make payments month after month, only to find out when it’s time to buy a bigger house or take out a home equity loan, there’s no equity to borrow against or use as a down payment. 

In other cases, buyers find that their mortgage payment has unexpectedly doubled just a few months after buying their home.  The outcome is that they can no longer afford the home in which they live.

Too often, buyers are seduced by low interest rates and commit to mortgages they don’t fully understand.  They buy into advertisements that seem to promise mortgages as low as one or two percent, while the rest of the industry is charging closer to five percent based on current market indicators. The truth is, the seemingly low rates are teaser rates on interest-only adjustable rate mortgages that only last a few months.

According to Roy Taylor of BancGROUP Mortgage, traditional adjustable rate mortgages, and the interest-only variety, have been around for decades.  Typically, their interest rates only change annually or can be fixed for periods up to10 years.  The advertisements promising super-low one and two percent interest rates are fixed for a significantly shorter period of time, generally only 30 days or so.  Once the shorter time period expires, the interest rates jump back to standard market levels. From there, the interest rate can go up or down on a monthly basis. Consumers are hearing more and more about interest-only programs because lenders are trying to get the phones ringing.

“Sure rates can go down,” Taylor said.  “But buyers should keep in mind we are still close to the bottom of a 30-year low period for interest rates.  Chances are they are going up from here.”

What’s worse is that these too-good-to-be-true programs are loaded with negative amortization.  If the borrower pays only the 1 ¼ percent advertised interest rate and not the fully indexed rate of five percent, the unpaid interest gets added back to the loan and the borrower ends up buried in mortgage debt, owing more at the end of the loan period than when the money was borrowed. 

“I tell clients three or four times a day how dangerous these programs are,” Taylor said.  “I’m tired of seeing people get hurt.”

Knowing that these programs are so often abused, Taylor hesitates to admit that in the right situation, an interest-only ARM can be a viable financing option for the informed borrower, but using a traditional fully indexed ARM product with an interest-only feature fixed for a period of time that meets the borrower’s needs.

They can make sense for self-employed or commissioned workers who periodically receive large bonuses that can be applied to the principle on a regular basis. And, in a two-person household where one of the wage earners temporarily leaves the work force, an interest-only ARM allows the borrowers to bridge the earning gap until the other source of income returns and principle payments can be made.

The benefit of this type of mortgage is that it can reduce the minimum payment by approximately 25 percent, compared to a conventional 30-year mortgage.  That’s a tremendous savings given today’s exploding home prices and a smart choice for the right borrower. 

In each of these scenarios, Taylor emphasizes the importance of choosing a program that the borrower can manage and regularly pay down principle.  All programs have a purpose.  But buyers need to make sure the purpose fits their needs and not the needs of the bank or mortgage lender.

For more information contact Roy Taylor at 630-953-9133 or by e-mail at rtaylor@bancgroup.org.