Buying a home on interest only

[oldminer]

NPR was hosting a show this morning on this subject and related topics. There were several positive aspects to considering this approach to home ownership although I'd be the first to admit it has no appeal to me. If I was just starting out, then I would definitely consider it as an alternative to renting.

My question is, what happens if you buy a home for $400K on an interest only loan and when the time comes to re-finance it on a conventional mortgage the value has dropped to $300K? Do you walk away from the home and let the lender have the house? Where do you get the lost $100K to pay off the initial interest only loan? This assumes there is a rather precipitous fall off in value of housing. The so-called bubble bursting that everyone expects yet no one wants to discuss. Do any of you have direct experience with interest only mortgages? Did any of you ask the question about falling values and if the home is the only security on the loan, or if the loan is also personally guaranteed by the rest of your assets?

 

[lmurden]

Great questions!

I don''t have the answers because I am not a home owner yet, but I do know for sure that my fiance and I are going to get a 30 year fixed mortgage by using either the VA Loan or an 80/20 Loan because we don''t want be in be holding the bag of a $100,000 loss in value on our home.

 

[oldminer]

LM: Buying a home with interest only or a regular mortgage does not change the fact that we may someday soon have a reversal in the strong upward trend of housing prices that has prevailed for so many years.If you tie up your capital in a traditional mortgage, then if values fall, you simply keep paying based on your mortgage. You can't sell if the sales amount won't pay off the loan balance unless you come up with additional cash. You can walk away, but you are losing all the money you put down and have paid into equity. With interest only, you have zero equity and no reason to pay for something that is not worth the money any longer.

The question is, can you walk away and let the lender have the house with no personal repercussion? It surely will ruin your credit rating, but will they come after your other assets? Is the house the only security for the loan, or do you guarantee payment personally? I wonder if anyone has even asked these questions?

 

[kenny]

Great questions.
Scary market.
I feel bad for young people starting out.
How can anyone afford a 20% down payment at today''s prices, not to mention mortgage payments today,
Even if you find a way to come up with 20% down, the monthly payments are astronomical.
Then property taxes on a $400,000 house. YIKES!

The 0% intrest loans are getting people into houses though.
There is a good chance most of them will remain employed and just keep making the payments even if prices fall and they are up side down.

Also, look at credit card debt.
If your balance is $5000 the minimum payment due may only be $15.
That doesn''t even cover the interest.

I think credit is too loose.
Sure customers should be responsible and live within their means, but I think we need tighter regulation of credit.
And I think these 0% mortgage loans should be first to go.

 

[Mara]

We have a house on IO, in the last 1.5 years it has gone up 25%...so basically we have 25% in 'equity'...I use the term loosely because it's not real $$ until you sell and realize the gains.

Anyway, at the time the housing market was not as insane as it is now, no way would we buy now in this market, period. Things are too inflated. But we got in at a good time, though we didn't know it then.

Anyway the bottom line for us is that if you are in the house for 5 years or less....in that 5 years with a regular 30 year P+I loan, your first 5 years are about 98% interest and 2% Principal. So our figuring (expecting to only be in this place 5-7 years, it's a starter home for us), why should we do P+I when we can invest the additional $$ ourselves and make out better than we could if we invested literally $2k a year for 5 years. The Principal payment for us at the end of 5 years was a whopping 10k. Big deal. It only makes sense IMO for someone to do P+I if you plan to be in the house long enough to actually rack up equity by paying down principal. BUT I'd also like to point out that with a very serious market correction, even if you did do P+I, there is no guarantee that Principal you paid won't be eaten up if the market falls dramatically.

I know it's not everyone's cup of tea to do IO and I know some are against it (DF!) , but we met with a financial planner and our accountant and spoke with several mortgage brokers, bottom line was we did alot of research. So this was the right thing for us and so far it has paid off. With 25% 'equity' in our place, even if the market falls 20% which would be a huge shock and I don't think a drop would be THAT much, then we are STILL in the black. If god forbid, it fell 30% and we were a bit in the red, chances are we would hold the house until it moved up again (and in this area in CA it will always go up again...) and then sell it to break even most likely. Also for us, in the next year or so we plan to start making larger lump sum payments to our principal to increase our equity in the house. I would not do an IO on a 10 year or 15 year or 30 year loan. It was a short term thing for us, a starter home for 5 years.

So anyhow, I think that if you know the positives and negatives of whatever you do in home buying, you are a step up above people who don't educate themselves on all the options. My two cents...there is actually a big thread on this from a few weeks ago that was very long and got heated..it'a sensitive subject.

Personally I think where people get into trouble is when they take out $$ against HELOC's and spend it on things like cars or trips or things that will not return $$ to them but instead is wasted. What if the house tanks and you are 100-200k in the hole because you felt rich with equity? Or when they overextend themselves and buy a house too expensive and HAVE to do do IO (we did not have to, we chose to, we could have easily done P+I) because they couldn't afford P+I and then the market tanks and they can't get out of the house or afford to hold it.

 

[allycat0303]

I like this thread because it applies to my situation right now.

I'm 25, and my boyfriend is 26. We are in the process of buying a house, and put down 30% downpayment. This is how I think of it:

a) We didn't buy a house thinking we would make a profit. It's a place to live.

a) Houses are probably not going to increase exponentially anymore. I think of it as stable market. I have no idea if house prices will plummet or not, but I pray that they won't.

b) We bought an inexpesive house $135 000. Now even if the market collapses completely, I have a hard time believing that a stand alone house with a large peice of land (for the city I live in) in this day and economy) will sell for LESS then $95 000.

c) It's never free to live anywhere, so our loss would be the equivalent of a moderately expensive apartment, rented for 7 years.

d) We can always stay in the house, and wait the cycle out, until we could sell and break even. I think housing markets fluctuate.

At least that's what I tell myself when I get scared

. I've never heard of intrest only loans though, does that mean you never pay the capital and never own any part of the house? Or maybe you pay intrest, sell really high and then take the profit?

 

[lmurden]

Date: 7/27/2005 12:18:02 PM
Author: oldminer
LM: Buying a home with interest only or a regular mortgage does not change the fact that we may someday soon have a reversal in the strong upward trend of housing prices that has prevailed for so many years.If you tie up your capital in a traditional mortgage, then if values fall, you simply keep paying based on your mortgage. You can''t sell if the sales amount won''t pay off the loan balance unless you come up with additional cash. You can walk away, but you are losing all the money you put down and have paid into equity. With interest only, you have zero equity and no reason to pay for something that is not worth the money any longer.

The question is, can you walk away and let the lender have the house with no personal repercussion? It surely will ruin your credit rating, but will they come after your other assets? Is the house the only security for the loan, or do you guarantee payment personally? I wonder if anyone has even asked these questions?

If I owned a house, I would not walk away from my house I would just wait it out! My best bet would be to buy a house that I could live in comfortably for the rest of my life with a fixed interest so that I don''t have to worry about out growing the home in five years or so. So I guess I will be waiting a while until we are able to do so.

 

[mrssalvo]

i have also heard somewhere that the people who buy close to major cities or ocean property etc. aren''t in as much risk of a housing bubble burst affecting them. The ones who can really take a hit are those buying in sprawl areas when they are 20+ miles from downtown and buying $350,000 houses on an IO loan. their property values are not increasing nearly as quickly and they could have a hard time re-selling when you can go to the next subdivision over and build a custom home for the same price. We actually have friends who have done an IO loan and just pay extra on their principal each month to help build up the equity. also, taking out a 2nd mortgage on an IO loan is playing with snakes in my opinion and chances are someone will get bit. I prefer a standard 15 year fixed morgage but I can see how they can be useful and helpful to those who have educated themselves.

 

[phoenixgirl]

I''m sure that somebody who is better at math than I can figure this out, but even if you have to sell your house below what you paid for it, aren''t the chances good that you will be better off than if you had rented? Renting, after all, is paying somebody else''s mortgage for them. You have nothing to show for it. So doesn''t it follow that if you have to come up with $10k or $50k or whatever to make up for the depreciation of your home to sell, that this is still less than what you probably would have paid in rent to live in a comparable place? I am figuring that if we had the type of economic situation where houses were suddenly worth significantly less than previous prices and everyone was in the red, selling my home would probably be the least of my concerns.

I guess the thing is that with all investments, people should be level-headed and realize there are no guarantees. It doesn''t matter what the assessor says or what similar homes are going for now . . . you won''t have a realized gain or loss until you decide to sell.

P.S. Don''t get me started on tax assessors! Homes in this area were undervalued for tax purposes for years, and this year they tried to remedy it, which meant that our tax assessment increased 85%! We live in a condominium and there are 5 other identical third-floor units, and 12 other units of the same lay-out and square footage on the first and second floors. Guess how much everybody else''s increased? 45%. The lady came over to discuss our appeal, and boy was she an idiot! I mean, a big one! And I got the impression that she was the only assessor for the whole city, which would explain the undervaluing for years.

Our increase was so much bigger than the rest because of our purchase price (um, hello, shouldn''t you be using a consistent method to figure out the value for all of them, not just penalizing people who purchased recently? And she missed that a guy in one of the identical units paid 7% more than we did in October of last year, so he got the standard 45% increase). Also, she saw the work permits for the kitchen reconstruction after our fire which was to return the kitchen to like condition. I can tell you, it looks nice because the stuff is new, but we got the cheapest of everything (laminate counters, linoleum floors, etc.). She wrote down how much the insurance company paid. Well, I can tell you that they paid for things like 58 hours of demolition and having to repaint after the contractor''s idiot neighbor did a ridiculously bad job the first time. That value does not represent the value of the new kitchen.

So the idiot lady is sitting in my living room (a room NOT remodeled), and she says, "Look how much nicer your walls are than everybody else''s! Your place is in such good condition! See, I looked at the MLS listing of this place, and it mentioned how nice it was." Guess what? We got the MLS listing from our agent. Any description of superior quality? No! I can''t wait until we get to point out what an idiot she is in front of the appeals board. We''re going to let her mention things like the MLS listing and cost of the repairs before we pull out the real info and ask her how on earth she can justify giving identical units different market values.

I am not very good at confrontation, and when she kept on blathering and actually told me my arguments were "unpersuasive," I was so frustrated that I got choked up and teary-eyed. I quickly thought to attribute it to the memory of the "traumatic fire" that "makes me upset to think about it." Then I made her talk to my husband because he is much better at placating and smooth-talking people. I just get mad.

 

[Sundial]

As a former banker I can tell you that you can''t just turn over the keys to your mortgage lender and walk away unscathed in these situations. Obviously it will effect your credit negatively and you are personally responsible for the debt.

 

[kenny]

Personally I feel that if a bank is stupid enough to write an interest-only loan using bubbled-out collateral that could very quickly quickly be worth less than the loan, they deserve to be stuck with the bad debt.

 

[Dancing Fire]

i said long time ago that these interest only loans is causing this housing bubble. if the banks requires the buyer to put down say 10-15%, then the housing market wouldn't of gotten out of control, like it is today. for the past 5 years the US economy has been running on this housing bubble,creating a lot of new jobs. when the interest rate goes up the bubble will burst. and alot of construction workers will lose their jobs and it will effect the whole food chain.on the other hand,if the housing market remain at this level,very low percentage of the people will able to afford a home.there's no solution to this problem ,it's to late to turn back now.

http://money.cnn.com/2005/07/20/news/economy/fed_greenspan/index.htm?cnn=yes

 

[OldBride]

I''m an attorney who has been working in the real estate field for many many years. People forget that the market is cyclical, and prices do drop. In the early 90''s here in California, we saw a rather dramatic decline in property values which meant lots and lots of foreclosures.
I would never have an interest only loan, or even worst a negative amortization loan. The economist from the MBA (Mortage Bankers Association) predicts a decline in real estate values in 2006 and 2007 of about 4 to 5 percent each year. I understand reasons for buying and selling personal residences right now, since even though you buy at inflated prices you are selling at inflated prices as well, and besides, it''s your home. However, I am amazed that there are still "investors" out there snapping up single family properties hoping to flip them and make a killing. To me, that''s as wise as investing in dotcoms in early 2000. But then again, I''m fairly conservative and I don''t have a pile of money to show for it.
So, if you have an interest only loan, or a neg arm and prices fall, in California, at least, you could walk from the home and let the lender foreclose without the treat of a deficiency judgment (unless it''s an FHA/VA loan which is another story). However, your credit would be screwed for a very long time, and THAT hurts.

I am not purporting to give any advice, but am merely offering my personal opinion and blah blah blah (insert weasel words here).

 

[Dancing Fire]

Date: 7/27/2005 4:52:36 PM
Author: phoenixgirl
I'm sure that somebody who is better at math than I can figure this out, but even if you have to sell your house below what you paid for it, aren't the chances good that you will be better off than if you had rented? Renting, after all, is paying somebody else's mortgage for them. You have nothing to show for it.

all depends,IO loans is no different than renting since you own 0 percentage of the house. if the housing market goes down,at least you're not stuck with a over priced home.

 

[OldBride]

An IO loan is much different from renting. First of all, you''ve signed the note and deed of trust or mortage and have obligated yourself to make the payment. If the lender forecloses and takes back the house, your credit is trashed. Secondly, if you are in a state that does not have good anti-deficiency laws, the lender may be able to foreclose and take the house, and also have a judgment against you for any deficiency that may be there after the resell the asset.

 

[Dancing Fire]

Date: 7/27/2005 7:19:30 PM
Author: OldBride
I''m an attorney who has been working in the real estate field for many many years. People forget that the market is cyclical, and prices do drop. In the early 90''s here in California, we saw a rather dramatic decline in property values which meant lots and lots of foreclosures.
I would never have an interest only loan, or even worst a negative amortization loan. The economist from the MBA (Mortage Bankers Association) predicts a decline in real estate values in 2006 and 2007 of about 4 to 5 percent each year. I understand reasons for buying and selling personal residences right now, since even though you buy at inflated prices you are selling at inflated prices as well, and besides, it''s your home. However, I am amazed that there are still ''investors'' out there snapping up single family properties hoping to flip them and make a killing. To me, that''s as wise as investing in dotcoms in early 2000. But then again, I''m fairly conservative and I don''t have a pile of money to show for it.
So, if you have an interest only loan, or a neg arm and prices fall, in California, at least, you could walk from the home and let the lender foreclose without the treat of a deficiency judgment (unless it''s an FHA/VA loan which is another story). However, your credit would be screwed for a very long time, and THAT hurts.

I am not purporting to give any advice, but am merely offering my personal opinion and blah blah blah (insert weasel words here).

OB
the problem is.....the young buyers of today haven''t been through that 90-97 down cycle. i think once the bubble burst ,the first 10% drop will be real quick and then continues to drift lower for 5-6 yrs.i been seeing the word "REDUCED" posted in front of the homes for sale around our area. 6 months ago, these homes would of been sold in 2 to 3 weeks and the owners would get more than their asking price.so, at least i know the housing party is over in our area.

 

[mrssalvo]

Date: 7/27/2005 7:26:39 PM
Author: Dancing Fire

Date: 7/27/2005 4:52:36 PM

Author: phoenixgirl

I''m sure that somebody who is better at math than I can figure this out, but even if you have to sell your house below what you paid for it, aren''t the chances good that you will be better off than if you had rented? Renting, after all, is paying somebody else''s mortgage for them. You have nothing to show for it.

all depends,IO loans is no different than renting since you own 0 percentage of the house. if the housing market goes down, you''re not stuck with a over price home.

but if it goes up, you''ll get the cash and may be able to put 10-20% down on your permanant/long term home that you never would have been able to do otherwise. Sure it''s a risk, some are willing to take it.

 

[perry]

I persononally know 2 people who lost 40-60% of the value of their "house" because of declining values and that they had to change jobs (either to a lower paying job, or to another state).

While most morgtages are affected by such things (for example, if the plant I work at closes housing value in the local area will severely plumet, and my job would be over); interest only loans put you in a far worse situation.

They are not for me.

Perry

 

[Dancing Fire]

Date: 7/27/2005 8:05:52 PM
Author: mrssalvo

Date: 7/27/2005 7:26:39 PM
Author: Dancing Fire

all depends,IO loans is no different than renting since you own 0 percentage of the house. if the housing market goes down, you''re not stuck with a over price home.

but if it goes up, you''ll get the cash and may be able to put 10-20% down on your permanant/long term home that you never would have been able to do otherwise. Sure it''s a risk, some are willing to take it.

yeah....but don''t forget, you''re also paying a bubble price for that more expensive permanant home.so for anybody that''s looking to upgrade their home,it''s better for the bubble to pop.

 

[mrssalvo]

I just think there are so many different variables, where you live, where your moving etc. it just not a one size fits all kind a thing.

ETA: I do think that 99% of the people who get them are using them to purchase homes they cannot afford and are taking a HUGE risk. But there are those who have researched and have been able to benefit from the help of and IO loan. It's something that individual's must look at and decide for themselves.

 

[aljdewey]

Date: 7/27/2005 4:52:36 PM
Author: phoenixgirl
I''m sure that somebody who is better at math than I can figure this out, but even if you have to sell your house below what you paid for it, aren''t the chances good that you will be better off than if you had rented? Renting, after all, is paying somebody else''s mortgage for them. You have nothing to show for it. So doesn''t it follow that if you have to come up with $10k or $50k or whatever to make up for the depreciation of your home to sell, that this is still less than what you probably would have paid in rent to live in a comparable place?

Precisely......and this is the same discussion Rich & I had when we were contemplating the scary move to homeownership. He worried about potential liability if the house lost value after we bought it. I replied with two comments. First, we were looking for a long-term purchase -- a 30-year house -- and the nature of real estate IS cyclical, so it goes down AND it goes up. As long as we could afford the present payments, we could afford to wait for an upswing.

Second, assume a hardship scenario where someone loses a job, etc. and we HAVE to sell in a down period......maybe we lose $40K or so. That was 2 years worth of rent to us. If we had rented for two years, that $40K would be blown with NO chance of seeing anything for it. It''s a sure loser.....where the house option has the *potential* to be a winner.

Finally.......I think it''s important to point out that it''s pretty unlikely the market is going to fall out by 20-25% overnight.......seriously. In the two years we''ve been watching the wild appreciation in my area, houses went from $260K to $320K in a given area. If it took them 2 years to go UP 80K in a red hot market, it''s going to take more than.....oh, say a MONTH......for them to lose value too. People who are smart in how they enter the I/O scenario and do all the research up front, as Mara did.....well, I have to imagine they are astute enough to keep an faithful eye on the market and not wait until it tanked beyond repair to unload the house.

 

[OldBride]

So long as you''re thinking of your purchase as your home and not an investment that you intend to "flip" in a short time, you''re probably fine. And don''t forget that mortgage interest is one of the few good tax write-offs that working people get.

 

[kittykat]

Correct me if I am wrong but I get the impression that when people refer to an I/O loan that they are under the assumption that it is always a 0% down loan. When I bought my first home I got a conventional 30 year fixed with 5% down and really regret not doing an interest only loan because I found a better house at a good deal and sold two years later (never planned on selling so quickly). Now I have an I/O loan for five years but we put 20% down from the revenue of the last house. I plan on watching the interest rates and refinance if I need to. I feel ok with it because I have 20% equity and because of my age (27the way I watch real estate I might be out of there in 5 or 10 years anyways.

 

[Mara]

".i been seeing the word ''REDUCED'' posted in front of the homes for sale around our area. 6 months ago, these homes would of been sold in 2 to 3 weeks and the owners would get more than their asking price.so, at least i know the housing party is over in our area. "

_____________________


DF it could be over in your area, if you live in an expensive area of the Bay, but in our more ''transitional'' area it''s just getting started. People who are getting priced out of nicer areas like Cupertino, MP, LA, PA etc are having to look elsewhere to see what they can afford and near us in Downtown SJ (near rose garden but outside of it) we are seeing lots of inflation right now. A house unit just like ours went up for sale a month ago, within a week it had a sale pending. They got what they were asking for if not about 20k over. When the unit went up for sale we were like...''yeah right they are not going to get that much'' but a week later there it was!!

And just today we got a letter in the mail, all the units in our complex did, from a realtor who is representing a couple who desperately wants to buy one of these townhouses...so if someone is thinking of selling, they could probably get whatever they were asking.

So for this area where we are which we actually really like, it''s an untapped resource that people are starting to discover, and we expect it to climb higher before it starts to drop....IF it does.

But we don''t plan to sell anyway for about another 5-6 years so this is all just speculation. However, once that unit up the block from us sells and goes on record, we can get a re-appraisal and re-finance into a lower rate and we''ll have 25% equity over our sale price (we''ll get entirely rid of our 2nd) so it''s good for us, so far.

Bottom line is that I think as long as people are educated on the positives and negatives of house buying and loans and what it all entails, and know what could go wrong, then at least you are aware and realistic and that is the best way to be prepared.

 

[Dancing Fire]

Date: 7/27/2005 9:39:55 PM
Author: Mara
near us in Downtown SJ (near rose garden but outside of it) we are seeing lots of inflation right now. A house unit just like ours went up for sale a month ago, within a week it had a sale pending. They got what they were asking for if not about 20k over.

i don''t know the SJ area but i used to do coin shows in the early 90''s at the old convention center. i take the bird ave exit.i remember there was a resturant call "ORIGINAL PETE''S" across the street at the corner. too many freeways in the SJ area,N&S 580,N&S 680,N&S 280,N&S 880. i get

So for this area where we are which we actually really like, it''s an untapped resource that people are starting to discover, and we expect it to climb higher before it starts to drop....IF it does.

you''re lucky to get in at a lower level but,it won''t be so lucky for some other people, whom will get stuck at much higher level.

But we don''t plan to sell anyway for about another 5-6 years so this is all just speculation. However, once that unit up the block from us sells and goes on record, we can get a re-appraisal and re-finance into a lower rate and we''ll have 25% equity over our sale price (we''ll get entirely rid of our 2nd) so it''s good for us, so far.

that''s the problem.if the market keep going up, your upgrade house will cost you 2 arms & 2 legs in 5-6 yrs from now.

 

[Mara]

I know DF...unless we can sell and then camp out under a bridge until the market tanks...

One option we discussed and part of the reason we did IO shorter term is that we may move out of state and then we could really reap the benefits of the inflation here if we go elsewhere and are able to put 60% down on a house that we want to keep long-term. Who knows. I love CA, doubt I could really ever leave.

 

[OldBride]

I live in Sacramento and my home has doubled in value in five years. Absurdly, I could not afford to buy my own home today, since my income has not doubled in the last five years. And I used to think Sacramento was cheap.....Since I''m 53 and my fiance is 56 (and we only have two kids still in college) our game plan is to retire in five years, sell the house and move to one of those big rectangle states, like Colorado.

But on the interest only loan question, I really wonder if it matters that much these days, since people seem to be refi-ing once a year and starting the whole amortization schedule over again each time.

 

[Dancing Fire]

Date: 7/28/2005 12:44:09 AM
Author: OldBride
I live in Sacramento and my home has doubled in value in five years. Absurdly, I could not afford to buy my own home today, since my income has not doubled in the last five years. And I used to think Sacramento was cheap.....Since I'm 53 and my fiance is 56 (and we only have two kids still in college) our game plan is to retire in five years, sell the house and move to one of those big rectangle states, like Colorado.

But on the interest only loan question, I really wonder if it matters that much these days, since people seem to be refi-ing once a year and starting the whole amortization schedule over again each time.

i think it's okay to refi into a lower rate but don't start the whole amortization schedule over again.say.... if you have 12 yrs left in your old loan,after you refi,make sure to pay the new loan off in 12 yrs or less. i have friends whom take home equity out to buy new cars that they couldn't afford and bury themselfs in debt.remember,equity isn't real money until you sell your home.

 

[Dancing Fire]

Date: 7/28/2005 12:29:21 AM
Author: Mara
I know DF...unless we can sell and then camp out under a bridge until the market tanks...

One option we discussed and part of the reason we did IO shorter term is that we may move out of state and then we could really reap the benefits of the inflation here if we go elsewhere and are able to put 60% down on a house that we want to keep long-term. Who knows. I love CA, doubt I could really ever leave.

don''t be surprise when you see people camp out under the bridge w/o a home in the near future.

 

[coconut]

We are in the market for a house in DC/VA area... the hottest spot in the nation so they say....
The prices went up 50% in the past 2 years!!!

However, if anyone was following lately,
Alan Greenspan announced that the housing prices in the Us are OVER inflated....
I heard that there is a great possiblity of an estimate of 6-8% decrease in price by the end of the year in certain cities: #1 being Boston MA, next being many of the ocean front properties in CA. By next year, the decrease will impact other major cities...

Now... in my opinion an 8% decrease in housing prices doesn''t really sound like much compared to the rapid increase..... Also, this must not necessarily mean that the housing prices won''t go up anymore now does it?? Perhaps this will be a window of opportunity for ppl for people in the market??



Also, if you can afford to pay for a house in full..... would you? or still mortgage and invest the money somewhere else?