By KATHLEEN PENDER
San Francisco Chronicle
As home prices continue to rise and interest rates inch above their record lows, more homeowners, especially in high-cost regions, are choosing interest-only mortgages.
These are 30-year mortgages that permit, but do not require, principal payment during an initial period, typically three, five or 10 years. After the initial period, homeowners must begin repaying principal over the remaining life of the loan.
By comparison, a traditional amortizing loan requires principal and interest payments from day one, with more of the monthly payment going to interest in the early years and to principal in the later years.
Homeowners can lower their monthly payment by 20 to 25 percent by skipping principal payments in the early years, but they must be prepared for a big jump in payments when the interest-only period ends.
At Wells Fargo Home Mortgage, about 20 percent of new loans are interest only, says Brad Blackwell, the firm's national sales manager.
At Quicken Loans, about a third of all home mortgages are interest only, with most of the growth coming in the last five months, says Bob Walters, the company's chief economist.
When they were introduced a few years ago, interest-only loans were marketed to wealthy, sophisticated home owners who wanted to borrow as much as they could (mortgage interest payments are tax deductible) and divert what they would have paid in principal into potentially higher-yielding investments.
Today, they are being pitched to homeowners who want to lower their monthly payment so they can buy a bigger (or any) house, and to people who want the flexibility of paying or not paying principal during the first few years.
Many lenders offer the interest-only option only on adjustable rate mortgages. With an ARM, the interest rate is typically fixed for the first few years, then begins floating. With an interest-only ARM, principal payments usually must begin when the fixed-rate period ends.
Some lenders, such as Countrywide Home Loans, offer interest-only options on fixed-rate as well as adjustable-rate mortgages.
Quicken Loans and Wells Fargo require customers to have good credit _ a minimum FICO credit score of 660 and 680, respectively _ to qualify for interest-only loans. Both companies make interest-only loans with a down payment as small as 5 percent.
Countrywide has no minimum down payment or credit requirements for interest-only loans.
Some lenders charge a slightly higher fee or interest rate when customers choose the interest-only option, some do not.
By lowering their initial monthly payment, many borrowers qualify for a bigger home loan than they would have with a traditional amortizing loan. But they're taking two risks with the interest-only loan.
One is that their income won't grow fast enough to cover the leap in mortgage payments after the interest-only period ends.
The other is that if housing prices fall, borrowers could end owing more on their home than it is worth.
"This is not a product for the masses. This is a product for a small segment of borrowers," says Greg McBride, a senior financial analyst with Bankrate.com.
An interest-only loan "is best used by a wealthier home owner, someone who doesn't need to lower payments to buy the house but can take advantage of those lower payments by maximizing their other investments," he says.
"It's a dangerous tool for someone who is evaluating a loan solely on payment affordability. If you can't afford the house when interest rates are at 6 percent, you have to ask yourself, when can you afford it?" says McBride.
Vijay Lala, a senior vice president with Countrywide, says interest-only loans are a good option for people who can afford to make principal payments, but want the option of skipping them if an emergency arises or a good investment opportunity come along.
"Having an interest-only loan takes discipline," he says. "A borrower needs to make sure they understand the terms."
(Distributed by Scripps Howard News Service, www.shns.com)
