Interest Only Loan - when is it a good idea?

eSDee · 03-22-2006, 05:40 PM

My girlfriend is trying to buy a condo and using the grants/loans that she is eligible for she comes up about 65 grand short of the place she wants to buy. A person recommended an interest only loan. I don't know anything about loans so I thought I would ask if anyone has either some good links or some good information about it. I imagine that my girl would want to live in her place 5 years before either refinancing or selling and moving on. Not sure if that provides and good information or not.

Thanks in advance!

MikeD · 03-22-2006, 05:44 PM

Paging LK...paging LK.

Cubsfan · 03-22-2006, 05:46 PM

Generally a bad idea. More or less, they simply allow someone to buy more house than they really should. If house prices go down, or if she gets a 100% loan, then she could be in for some big trouble.

Say she takes a 100% loan on a $100k place. When it comes time to sell, if she's only paid the loan off, then she still owes $100k. Then you have to factor in the 6% for real estate agents, and she needs to come up with $6k just to sell the place.

Ok, now that I reread your question, maybe she's going to have a large down payment. If that's true, then it's not quite so bad. She'll still basically never be paying off the loan through her payments though.

johnnymk · 03-22-2006, 06:20 PM

It's like renting from the bank, but she can deduct her interest and taxes from her Federal Income Tax.

LegendKiller · 03-22-2006, 07:49 PM

My biggest problem with IO is that you, as Zippy mentioned, are essentially not buildinig any equity. Your whole house revolves around the fact that it will appreciate for you to get any value out of it. If it goes down in value, you are flipped.

Furthermore, it's really bad for people who are using the IO term to just barely afford the payments. If the IO unlocks and their payment doubles, they have to sell. If the value went down, they are screwed. Can't sell for as much as the mortgage is worth, can't hold onto it to ride out the storm for eventual appreciation.

Furthermore, you are essentially, as johnny said, renting from the bank.

However, in the case of somebody who already has a ton of money in the condo, it might not be a bad idea. If you look at how much you are paying for principal as compared to interest ini the first 10 years, it ain't much.

zippyjuan · 03-22-2006, 11:15 PM

My initial reaction is that she is trying to buy more than she can afford. Many lenders now will allow you to spend 50% of your take home pay on housing. That used to be 30%. If she needs to spend more than that, it will not take much of a change in her financial situation (out of work for any reason or even cut back on work), paying bills will be impossible. She needs to calculate what her payment would be on what she is borrowing and also include any homeowners fees (I pay over $200 a month for the homeowners fees for my one bedroom condo which is probably close to average) which will be on top of her mortgage payment. I estimate getting back the property taxes as part of the deduction of interest paid on my income tax so I do not include that in the cost. Pluls maintaining the property or making any improvements like new carpet or painting.

How much less could she rent for? In normal circumstances, condo prices (monthly costs) tend to be fairly close to what comparable units rent for, but in San Diego right now there is a large gap with people wanting to buy some sort of a home but find themselves priced out of most houses are looking at condos. I am sure you have seen all the construction and conversions of apartments to condos too. This will probably lead to an over supply in a couple of years and if that is combined with higher interest rates, the prices of condos will fall. Mine has already been going down. A one bedroom (two bedrooms and studios are also available) in my building (30 years old) peaked at $360,000 for the most expensive one sold to around $275,000 now. I was lucky enough to get in when they were more affordable. So given the possible direction of condo prices and the gap between what she can pay to rent, she may be better off renting for now and saving the difference towards a place in the future. Especially considering the points made earlier about not gaining or even losing equity if prices stay flat or even do go down which could leave a situation where she owed more than the place could be sold for.

For more information, here is a quick article about interest only loans: http://www.bankrate.com/brm/news/mtg/20020620b.asp

mcs328 · 03-23-2006, 08:58 AM

So she's 65K short. She would need a loan for about 65K at the going interest rate of 6.5% on the high side. On a 30 year fixed Principal and Interest loan her monthly would be about $425/month not including condo fees and property tax. So I think the interest only rate is lower right but it's all interest in the first 10 years and the last 20 years it's all principal you owe which is the orginal 65K.

So is my math right and can she afford the monthly payments? As long as the value of her condo doesn't go down I don't see why not because she gets to save on her Federal taxes which might pay for itself when you consider all the fees she pays buying and selling the place.

eSDee · 03-23-2006, 12:18 PM

Thanks everyone for your input. She will be able to afford her mortgage because I will be moving in with her and will be paying more than half of it. She actually qualifies for more than I do even though I make a lot more money than her, because there are programs within San Diego that give you money if you make under at Area Median Income. Using these programs gets her to about 65k short of a place that although in a tougher neighborhood (city heights) is up and coming. Less and less crack houses every day. So, she is 65 k short, and is now being recommended to do an interest only loan. It sounds like it is not that good of an idea.

She met with her loan agent again last night and I haven't had a chance to talk to her about it yet. I will post more info as it comes. Thank you very much for your great insight everyone.

LegendKiller · 03-23-2006, 01:34 PM

Heh, I misunderstood what you had down.

In the case of "65k short", I thought she was taking out a 65k loan, only.

However, it looks like you mean that she is 65k short for her desired loan amount??

She qualifies for 300 but the place is 365?

eSDee · 03-23-2006, 01:44 PM

Exactly LK.

InfiniteNothing · 03-23-2006, 01:46 PM

Hey, is there a way to do the loan, "Stated Income"? That may be a good way out of an interest only loan (Where you'll end up paying alot more over the term of the loan). Also consider hunting for a lower interest rate. If the interest rate goes down she'll qualify for more house.

LegendKiller · 03-23-2006, 01:51 PM

Quote:

Originally Posted by InfiniteNothing

Hey, is there a way to do the loan, "Stated Income"? That may be a good way out of an interest only loan (Where you'll end up paying alot more over the term of the loan). Also consider hunting for a lower interest rate. If the interest rate goes down she'll qualify for more house.

It'd probably not go down enough.

EssDee, I'd actually recommend that she not get the place if she needs to get an IO. Using an IO to stretch up to that amount exposes an owner to a huge amount of risk. If prices go down within the period she faces the unlocking of principal and she can't afford it then, then she will be flipped and have to sell for a loss, owing on something she doesn't own.

If you are there to supplement her income, thats a little different.

SD is an awesome place to live and could potentially become a big hit if more retirees go there instead of hurricane prone FL. However, I'd say the chances of her being burned by an IO are greater than a second wind boom.

InfiniteNothing · 03-23-2006, 01:56 PM

What do you think about a stated income so she could go for a fixed rate 30y LK?

zippyjuan · 03-23-2006, 04:08 PM

You can explore some options here: http://www.freddiemac.com/singlefami...ages/need.html
Of course things also depend on how much she can put down (less than 20% and she will probably also have to pay PMI insurance- another expense) and her credit rating. Even if you are moving in, I don't think they will count your income unless you either cosign the loan or get your own loan. What would happen if you broke up? I am still concerned that she is trying to borrow too much.

Itsme · 03-26-2006, 12:10 PM

I learned a lot from the discussion here, and the references.

My duaghter is looking for her first place...in this case a condo. Her mortgage broker is suggesting an interest-only loan, and I was concerned about it.

In her case she is putting doen a healthy down payment $100K on a $325K place...so her loan is (only) $225. She intends to be in the place 5-7 years.

Seems like while a fixed rate loan is most always the preferred way to go (assuming the rate is nice an low), in her situation, with the good down payment, she should be ok with an IO loan.

eSDee · 03-27-2006, 11:30 AM

Thanks to everyone for the advice and linkage. I think that based on what you all have said it is probably not a good idea for her to get the IO loan. We will explore some other avenues towards getting this place. I appreciate all your input as purchasing a home for the first time is such a foreign concept.

mcs328 · 03-27-2006, 01:52 PM

I think IO loans were good a few years ago where you could flip the property and have the increase in sale price cover all the interest you paid out as mortgage thereby living rent free and maybe profit also. Now I don't see the 50% increase in value happening anytime soon to take a chance on an IO loan.

03-22-2006, 05:40 PM	#1
eSDee Old Skooler Numba 1 Join Date: Nov 2000 Location: Diego Posts: 10,063	Interest Only Loan - when is it a good idea? My girlfriend is trying to buy a condo and using the grants/loans that she is eligible for she comes up about 65 grand short of the place she wants to buy. A person recommended an interest only loan. I don't know anything about loans so I thought I would ask if anyone has either some good links or some good information about it. I imagine that my girl would want to live in her place 5 years before either refinancing or selling and moving on. Not sure if that provides and good information or not. Thanks in advance! __________________ ~~~~~~~~~~~~ 3 days ~ Willie Nelson 3 days I dread to see arrive 3 days I hate to be alive 3 days filled with tears and sorrow yesterday today and tomorrow

03-22-2006, 05:44 PM	#2
MikeD President, Cowboys Nation Join Date: Dec 2004 Location: In the 'burbs, west of D.C. Posts: 5,139	Paging LK...paging LK. __________________

03-22-2006, 11:15 PM	#6
zippyjuan Picture of the Day Guru Join Date: Oct 2002 Location: Sunny San Diego Posts: 8,756	My initial reaction is that she is trying to buy more than she can afford. Many lenders now will allow you to spend 50% of your take home pay on housing. That used to be 30%. If she needs to spend more than that, it will not take much of a change in her financial situation (out of work for any reason or even cut back on work), paying bills will be impossible. She needs to calculate what her payment would be on what she is borrowing and also include any homeowners fees (I pay over $200 a month for the homeowners fees for my one bedroom condo which is probably close to average) which will be on top of her mortgage payment. I estimate getting back the property taxes as part of the deduction of interest paid on my income tax so I do not include that in the cost. Pluls maintaining the property or making any improvements like new carpet or painting. How much less could she rent for? In normal circumstances, condo prices (monthly costs) tend to be fairly close to what comparable units rent for, but in San Diego right now there is a large gap with people wanting to buy some sort of a home but find themselves priced out of most houses are looking at condos. I am sure you have seen all the construction and conversions of apartments to condos too. This will probably lead to an over supply in a couple of years and if that is combined with higher interest rates, the prices of condos will fall. Mine has already been going down. A one bedroom (two bedrooms and studios are also available) in my building (30 years old) peaked at $360,000 for the most expensive one sold to around $275,000 now. I was lucky enough to get in when they were more affordable. So given the possible direction of condo prices and the gap between what she can pay to rent, she may be better off renting for now and saving the difference towards a place in the future. Especially considering the points made earlier about not gaining or even losing equity if prices stay flat or even do go down which could leave a situation where she owed more than the place could be sold for. For more information, here is a quick article about interest only loans: http://www.bankrate.com/brm/news/mtg/20020620b.asp __________________ I add new pictures to my photo gallery pretty regularly. You can see them here if you are interested: http://www.pbase.com/jeffryz

03-23-2006, 08:58 AM	#7
mcs328 Admiral Join Date: Feb 2001 Location: Maryland Posts: 6,578	So she's 65K short. She would need a loan for about 65K at the going interest rate of 6.5% on the high side. On a 30 year fixed Principal and Interest loan her monthly would be about $425/month not including condo fees and property tax. So I think the interest only rate is lower right but it's all interest in the first 10 years and the last 20 years it's all principal you owe which is the orginal 65K. So is my math right and can she afford the monthly payments? As long as the value of her condo doesn't go down I don't see why not because she gets to save on her Federal taxes which might pay for itself when you consider all the fees she pays buying and selling the place. __________________

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03-22-2006, 05:46 PM	#3
Cubsfan Rear Admiral Lower Half Join Date: Jul 2001 Location: Colorado Posts: 2,743	Generally a bad idea. More or less, they simply allow someone to buy more house than they really should. If house prices go down, or if she gets a 100% loan, then she could be in for some big trouble. Say she takes a 100% loan on a $100k place. When it comes time to sell, if she's only paid the loan off, then she still owes $100k. Then you have to factor in the 6% for real estate agents, and she needs to come up with $6k just to sell the place. Ok, now that I reread your question, maybe she's going to have a large down payment. If that's true, then it's not quite so bad. She'll still basically never be paying off the loan through her payments though.

03-22-2006, 06:20 PM	#4
johnnymk Chief of Naval Operations Join Date: May 2000 Location: LEVITTOWN< PA> USA Posts: 13,621	It's like renting from the bank, but she can deduct her interest and taxes from her Federal Income Tax.

03-22-2006, 07:49 PM	#5
LegendKiller Vice Admiral Join Date: Jun 2002 Location: Northern VA Posts: 4,927	My biggest problem with IO is that you, as Zippy mentioned, are essentially not buildinig any equity. Your whole house revolves around the fact that it will appreciate for you to get any value out of it. If it goes down in value, you are flipped. Furthermore, it's really bad for people who are using the IO term to just barely afford the payments. If the IO unlocks and their payment doubles, they have to sell. If the value went down, they are screwed. Can't sell for as much as the mortgage is worth, can't hold onto it to ride out the storm for eventual appreciation. Furthermore, you are essentially, as johnny said, renting from the bank. However, in the case of somebody who already has a ton of money in the condo, it might not be a bad idea. If you look at how much you are paying for principal as compared to interest ini the first 10 years, it ain't much.

03-23-2006, 12:18 PM	#8
eSDee Old Skooler Numba 1 Join Date: Nov 2000 Location: Diego Posts: 10,063	Thanks everyone for your input. She will be able to afford her mortgage because I will be moving in with her and will be paying more than half of it. She actually qualifies for more than I do even though I make a lot more money than her, because there are programs within San Diego that give you money if you make under at Area Median Income. Using these programs gets her to about 65k short of a place that although in a tougher neighborhood (city heights) is up and coming. Less and less crack houses every day. So, she is 65 k short, and is now being recommended to do an interest only loan. It sounds like it is not that good of an idea. She met with her loan agent again last night and I haven't had a chance to talk to her about it yet. I will post more info as it comes. Thank you very much for your great insight everyone.

03-23-2006, 01:34 PM	#9
LegendKiller Vice Admiral Join Date: Jun 2002 Location: Northern VA Posts: 4,927	Heh, I misunderstood what you had down. In the case of "65k short", I thought she was taking out a 65k loan, only. However, it looks like you mean that she is 65k short for her desired loan amount?? She qualifies for 300 but the place is 365?

03-23-2006, 01:44 PM	#10
eSDee Old Skooler Numba 1 Join Date: Nov 2000 Location: Diego Posts: 10,063	Exactly LK.

03-23-2006, 01:46 PM	#11
InfiniteNothing Chief of Naval Operations Join Date: Aug 2002 Location: San Diego Posts: 10,086	Hey, is there a way to do the loan, "Stated Income"? That may be a good way out of an interest only loan (Where you'll end up paying alot more over the term of the loan). Also consider hunting for a lower interest rate. If the interest rate goes down she'll qualify for more house.

03-23-2006, 01:56 PM	#13
InfiniteNothing Chief of Naval Operations Join Date: Aug 2002 Location: San Diego Posts: 10,086	What do you think about a stated income so she could go for a fixed rate 30y LK?

03-23-2006, 04:08 PM	#14
zippyjuan Picture of the Day Guru Join Date: Oct 2002 Location: Sunny San Diego Posts: 8,756	You can explore some options here: http://www.freddiemac.com/singlefami...ages/need.html Of course things also depend on how much she can put down (less than 20% and she will probably also have to pay PMI insurance- another expense) and her credit rating. Even if you are moving in, I don't think they will count your income unless you either cosign the loan or get your own loan. What would happen if you broke up? I am still concerned that she is trying to borrow too much.

03-26-2006, 12:10 PM	#15
Itsme Vice Admiral Join Date: Aug 2004 Location: Southern California Posts: 4,813	I learned a lot from the discussion here, and the references. My duaghter is looking for her first place...in this case a condo. Her mortgage broker is suggesting an interest-only loan, and I was concerned about it. In her case she is putting doen a healthy down payment $100K on a $325K place...so her loan is (only) $225. She intends to be in the place 5-7 years. Seems like while a fixed rate loan is most always the preferred way to go (assuming the rate is nice an low), in her situation, with the good down payment, she should be ok with an IO loan.

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03-27-2006, 11:30 AM	#16
eSDee Old Skooler Numba 1 Join Date: Nov 2000 Location: Diego Posts: 10,063	Thanks to everyone for the advice and linkage. I think that based on what you all have said it is probably not a good idea for her to get the IO loan. We will explore some other avenues towards getting this place. I appreciate all your input as purchasing a home for the first time is such a foreign concept.

03-27-2006, 01:52 PM	#17
mcs328 Admiral Join Date: Feb 2001 Location: Maryland Posts: 6,578	I think IO loans were good a few years ago where you could flip the property and have the increase in sale price cover all the interest you paid out as mortgage thereby living rent free and maybe profit also. Now I don't see the 50% increase in value happening anytime soon to take a chance on an IO loan.