Are Interest-Only Mortgages Ever a Good Move?

Lower monthly payments are the appeal of interest-only mortgages. But, as you may have found out the hard way, those low payments don’t last forever. The chart at right tells the story. Above is the payment structure for an interest-only mortgage, and beneath it, the way a conventional home loan is set up.

Typically, within 5-7 years, the borrower must start to pay principal and the payments jump skyward. Below, three financial advisors dissect these exotic, increasingly popular Florida home mortgage financing options to help you determine if such a route is right for you.

ADVISOR #1: The quick answer to this question? Never.

This is especially true if the loan is variable and interest rates are rising. Unless the borrower has access to a substantial amount of liquid capital that can be used to fund the higher debt service, retire or refinance the principal, the property could quickly become the subject of foreclosure, which often results in a substantial loss of equity at the very least.

These types of Florida mortgage loans were popular with speculators in areas that were experiencing rapidly appreciating real estate values. A lot of times, these properties were financed with interest-only mortgages in order to minimize the capital required to hold them for a short period before they were sold for a profit.

As long as property values were rising, all parties involved realized a profit. The story is not so good for speculators that are still holding real estate when interest rates rise and values fall. They can quickly find themselves owing more than the property is worth.

At present, interest rates are still relatively low by historical measures, and one of the best financial moves a person can make is to secure a low fixed-rate Florida mortgage for 30 years. Since the payments stay stable for the life of the loan, payment shock is avoided with traditional fixed-rate mortgages as compared to the variable loan products.

ADVISOR #2: Caution and understanding the terms of the mortgage should be the rule. Listed below are just three situations where an interest-only Florida mortgage may be worth exploring.

When real estate investors purchase a property with the intent of selling the property at a profit, an interest-only mortgage ties up the least amount of cash up front.

In markets like some areas of Northeast Florida, where real estate is rapidly appreciating (just as the Southern part of the state did from 2001-2005) and the investor plans to sell the property in a relatively short period of time and wants the lowest payment, an interest-only mortgage may be best. The investor should keep in mind, however, that there’s no guarantee anything will continue to appreciate.

Additionally, if an investor currently has limited funds to devote to a monthly payment, but anticipates a large increase in income within a few years, an interest-only mortgage converting to a fixed rate may be a solution to consider.

Each individual financial situation is different. Understanding all aspects of the Florida home loan and what happens in the event of all circumstances that may arise is very important. Both a competent mortgage professional and financial adviser are able to help wade through the options and what may be most prudent for the consumer.

ADVISOR #3: These loans require you to pay only interest during the first 5-10 years of your interest-only loan. This results in monthly payment that is lower than a 30-year conventional Florida mortgage. You can, and should pay principal, at least in part, during this time.

Interest-only Florida home loans can have a fixed interest rate or can be adjustable-rate mortgages. If they are adjustable, rates can change every six months. Some people use these in the wrong way. You should not buy a bigger house than you can afford! There is a lot of upkeep and additional cost on top of your monthly payment.

Interest-only loans make sense if:

• Your income is in the form of infrequent commissions or bonuses.
• You’re confident you will have an increase in earnings in a few years.
• You plan on saving or investing the difference between interest-only and a conventional Florida mortgage.
• Values are increasing in your area. Increases in the value of your home build equity.
• You are comfortable being a risk-taker and are experienced in investing in appreciating real estate.

If an interest-only loan is the only way to afford a home, you should reconsider. You should not spend the difference you save by choosing an interest-only loan. You may wind up at the end of five years without any home equity. Be cautious and make sure the loan provider explains all the details to you.