Getting Interested

0 Comments | Gazette, The (Colorado Springs), Aug 30, 2004 | by SARAH COLWELL THE GAZETTE

Home buyers looking for ways to hold down the cost of buying a house have a new loan option -- an interestonly mortgage.

"Flexibility is the biggest benefit for the interest-only mortgage," said Jon Paukovich, director of lending at Ent Federal Credit Union. "For borrowers, it... allows them to apply their principal to other opportunities that may be better for their financial situation."

With traditional mortgages, the monthly payment consists of an interest portion and a principal portion; over time, the amount going to interest decreases and the amount to principal increases until the loan is paid in full.

With an interest-only mortgage, borrowers pay only interest in the early years of the loan; later, principal payments kick in, too, but at a higher level than with a traditional mortgage because they're paid over a shorter period of time.

A variety of interest-only loans are available, some that adjust every time a bank's prime lending rate changes. Others have fixed rates for three, five, seven or 10 years before they're adjusted. Most adjustment rates have an annual cap of 2 percent and a lifetime cap of 5 percent, Paukovich said.

Proponents of interest-only mortgages say they're a boon to families who need lower monthly payments to qualify for a mortgage. But mortgage consultant Michael Gordon of CTX Mortgage Co. in Colorado Springs warns that this could entice families to commit to more than they can afford in the long run.

Take the classic case of a young couple buying their first home, said financial counselor Eric Tyson, co-author of "Mortgages for Dummies."

"An interest-only mortgage gives them a low payment that may be all they can afford in the beginning," he said. "But say five or seven years down the road, when the payment jumps, maybe one of them isn't working anymore because they have a baby. In that case, a higher payment isn't going to work well."

Gordon gave this scenario for a family that needs a $250,000 mortgage:

With a traditional, 30-year mortgage carrying a 5.875 percent interest rate, a family would have to pay $1,479 each month in principal and interest for the duration of the loan.

At the beginning, an interest-only mortgage probably would carry a slightly lower rate, 5 percent, and monthly payments for the first five years would be $1,042, covering only the interest due. That's a monthly difference of $437 from the traditional loan. After that, the rate likely would jump 2 percent, requiring a monthly payment of $1,458.

The balance after that 60-month period for a traditional mortgage is $232,273; the balance for the interest-only loan is the original balance of $250,000. The interest paid after 60 months on the traditional loan is $71,004; the interest-only loan is $62,520 -- an interest savings of $8,484 over the traditional loan.

One concern about these mortgages is that families are not building equity in their homes in the early years because they are not making any principal payments.

"The problem first-time home buyers run into is they don't have a lot of money to put on the down payment. If they have a 100 percent interest-only mortgage on a $150,000, after two years they will still owe $150,000," Gordon said. "In a sense they have lived in their home for two years, paid interest and haven't made any money on the house. In this case they probably would have been better off renting."

James Moore, senior vice president of corporate communications at Ent, counters that even with a traditional mortgage, most of the money in early payments goes to interest. Therefore, most people gain equity from appreciation and not principal payments.

"It's only after you've been in a house some years that you get to see a significant gain in appreciation," he said. "Say perhaps you're in the military and only going to be stationed here for three years. You're probably not going to build up that much equity, so interest- only mortgage might be a good option."

Financial experts also said consumers who take interest-only mortgages can use the money they save on their early payments for other purposes, such as buying home furnishings, paying off credit card debt or saving for a child's college tuition.

"That may be a better use of their money in relation to their overall financial goals," Gordon said.

In July, Ent Federal Credit Union began offering two 30-year, fixed-rate Fannie Mae InterestFirst mortgage products for clients in El Paso County. This past year, CTX Mortgage Co. has provided more than 15 interest-only mortgages to clients and anticipates offering more in the future.

"The more people learn about (interestonly mortgages), the more programs there will be and the more programs associated with them," Gordon said. "The more lending options people have, the better."

No matter what option home buyers choose for their mortgage, Ent's Paukovich suggests families make sure they discuss each option with their lending agent.

"As a general rule of thumb, anyone looking to buy a home needs to consider all of their options and be very careful assessing their own financial needs and goals," he said.