Columnist Lew Sichelman addressed the following question in his recent mailbag: if a person has a condo for sale with no Florida mortgage, and anticipate selling within the next 12-24 months, should he/she opt for an interest-only mortgage?
Robert J. Bruss, a lawyer and real estate broker, replies to inquiries about housing and mortgages in his syndicated column.
In his most recent Q & A session, he addresses interest-only mortgages — something many of us in Florida know all too well about. Are they all bad? When would they be a good option, if ever? The answer may surprise you. Let’s take a look at what Mr. Bruss has to say about these exotic Florida home loan financing options.
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Q: I have around $300,000 equity in my home. My current mortgage balance is only about $34,000. Although I am retired and in good health, I am “only” 64, so a reverse mortgage won’t give me much because I am too young. I have a decent retirement income, but not enough to afford to go with my friends on cruises and afford other frivolous expenses.
The banker at my community bank, where my late husband did business for many years, suggests I get a 30-year fixed-rate mortgage with “interest only” payments for the first 10 years. There is no negative amortization, which you often warn about. He says I can easily afford the monthly payments, even after they “adjust” in 10 years to pay off the loan in 20 more years. My children advise against it. Your opinion, please!
A: Go for it! Enjoy your home equity. It is possible that your children realize you will be spending what will be their inheritance so they want to discourage you from fully enjoying your retirement while you are still in good health. There is nothing necessarily bad with interest-only mortgages that don’t have negative amortization.
Basically, from how you’ve described it, the Florida mortgage option you have in front of you sounds ideal as long as you can afford the monthly payments on your retirement income, both now and in 10 years when the monthly payment adjusts.
The type of mortgage that gets homeowners in financial trouble is the so-called “option ARM” where the monthly payments are so low they don’t even pay the interest. When that happens, the lender adds the unpaid interest to the Florida mortgage loan balance, resulting in negative amortization where the borrower owes more than the original balance.
As rising Florida home loan costs make buying a home more and more difficult, demand has soared for fixed-rate, interest-only mortgages, according to the Wall Street Journal.
This recently-introduced type of mortgage offers the security of a fixed rate, but the relatively low monthly payments in the loan’s early years that appeal to cash-strapped buyers in today’s financial environment.
Fixed-rate interest-only mortgages allow borrowers to lock in to Florida home loan rates for the duration. All the while, they will reduce their monthly costs by paying interest and no principal. This typically occurs during the first 10-15 years of a 30-year loan. These Florida home loan options, which barely existed two years ago, now account for roughly 8 percent of all new residential mortgages, says financial services firm UBS AG.
The growing demand for them illustrates the adjustments applicants are making as Florida home loan rates have climbed to their highest levels in four years and the gap between short- and long-term interest rates has narrowed. Rates on 30-year fixed-rate mortgages currently average 6.56 percent, according to the Mortgage Bankers Association. Adjustable-rate mortgages, which many have long relied on to lower monthly payments, have climbed even more sharply.
Major U.S. lenders are taking advantage of this new demand.
But these Florida home loan opportunities have significant drawbacks, namely the fact that borrowers do not build any home equity, aside from any rise in property values. Homeowners will also be hit with drastically higher payments once the interest-only period ends. Payments in the home loan’s later years include both interest and principal (in other words, the full PITI), and the balances must be paid off.
Moreover, the savings aren’t as great as you might imagine, as fixed-rate interest-only loans typically go for 0.125-0.375 percent more than the rate of a standard 30-year fixed-rate mortgage. For instance, a $300,000 standard 30-year fixed-rate loan with a 6.62 percent rate would have a monthly payment of $1,920, while an interest-only mortgage with a 6.75 percent rate would cost you $1,687 a month, according to HSH Associates. But that bill could jump 35 percent to $2,281 a month when the interest-only period ends in 10 years if you don’t sell the house or refinance.
Greg McBride, a senior financial analyst with Bankrate.com, says that in order to reduce payment shock, borrowers who take out these Florida home loans should try to make principal payments as often as they can. As you pay down the principal, the required interest-only loan payment is reduced to reflect the lower remaining balance. According to UBS, borrowers with these Florida home loans tend to finance more of their home’s value and were more likely to have a second mortgage.
Some analysts say, however, that the savings from taking out a fixed-rate interest-only loan will diminish as mortgage rates rise. Because at higher interest rates, more of your payment goes toward paying interest rather than principal. Mortgage analysts still say that fixed-rate interest-only loans are less risky than other types of interest-only mortgages, for the interest-only period lasts for a decade. Chances are good that people will move or see their incomes grow before the payment resets.
The fixed-rate interest-only loan is the latest in a long line of mortgage products designed to boost housing affordability. Borrowers have embraced interest-only adjustable-rate mortgages in recent years, along with option ARMs that carry teaser rates of as low as 1 percent but lead to a rising loan balance later on. Then there are so-called piggyback loans that allow buyers to finance up to 100 percent of a home’s purchase price. Such home loans have fueled the recent South Florida real estate boom.
All good things must come to an end, however. With Florida home loan rates and foreclosures on the rise, regulators are weighing new rules designed to rein in the use of nontraditional mortgage products that may pose risks to both borrowers and lenders. Be sure if you apply for a Florida home loan that you understand the risks and benefits of non-traditional options. If it sounds too good to be true, it probably is.
So, you’re stuck in credit card debt. And you’d like to eliminate this problem as quickly as possible. While we’ve discussed using your home equity to take care of this problem, another question often arises:
Can an interest-only Florida home loan help to consolidate debt?
Various ways to deal with credit card debt
Let’s say you possess $20,000 in outstanding credit card bills. Replacing this amount with $20,000 in mortgage debt isn’t exactly taking care of the problem - it’s just restructuring your debts. This is the typical consequence for those thtat consider an interest-only mortgage. It’s simply postponing different kinds of payments.
The monthly mortgage payment on a conventional fixed-rate mortgage is self-amortizing, meaning the monthly payment contains BOTH the monthly interest expense and a contribution to the principal that allows the mortgage to be paid off over the life of the loan.
However, an interest-only mortgage does NOT have the principal repayment component, at least not in the early years of the loan, so it allows you to minimize your monthly mortgage payment. This sort of package can help a homeowner qualify for a bigger house or free up funds for other purposes … but it could spell trouble down the line.
Details of an interest-only Florida home loan
Interest-only mortgages are commonly adjustable-rate mortgages, or ARMs, but they can also have a fixed initial term. Restructuring your debt to interest-only debt can free up some financial slack in your monthly spending plan, but that slack comes at a pretty big price.
You’ll take on the interest rate risk of an adjustable-rate loan, the closing costs associated with a new first mortgage and stop paying down your loan balances. Initally, you may free up a few hundred dollars per month - and this cash could be used on your remaining credit card bills. But you’ll still have the balance of your Florida home loan to eventually pay off.
This approach is not recommended unless you were up against it in meeting your monthly bills. Even then, using a second mortgage can be an easier approach than totally restructuring your debts. Keep in mind you’ll pay a few thousand dollars in closing costs to get a new first mortgage and only a few hundred to get a new second mortgage.
In the end, don’t jump all over a Florida home loan simply because monthly payments will be low for the first couple years. If you know you’ll be coming into money down the line, then an interest-only package may be up your financial alley. But there are other ways to avoid debt that may not be as hazardous to the long-term health of your bank account.
