Interest Only Loans - The Devil or a Godsend?
I read this blog today that got my wheels spinning. The topic: Interest only loans. Interest only loans have a nasty reputation as foreclosure loans or "rent" loans. Heaped into the same pile are negative amortization loans, no doc loans, stated income loans, and others like it. But in my opinion, we are throwing the baby out with the bath water.
These loans are TOXIC!?!?
You don't have to convince me. And please don't try to. Lets try and create a quick parallel. We all use various tools every day; knives, can openers, lawn mowers, bleach, Jack Daniels. Where we run into the real problem is when these tools are misused OR they are given to the wrong people.
You don't give a 3 year old a steak knife. And your 5 year old shouldn't be mowing the grass. Your 16 year old shouldn't be downing Jack Daniels. They are all the wrong match for these "tools".
An interest only loan is a tool. Just like a 15 year loan is a tool. Think I am off my rocker?? I'll show you borrowers that are so aggressive in taking a 15 year loan that they put their family at far more risk than if they had an interest only loan. Point in case: If you are stretching to make 15 year loan payments, it leaves little money in the bank. When an emergency comes along, where does this person get money from? They borrower it via credit cards, bank loans, or maybe a refinance. This situation puts a homeowner in a much worse scenario and more than cancels out all of their pre-payment strategies. It may even put them into foreclosure, which would be doubly sad if they spent years aggressively paying down their home loan only to lose every cent to the bank.
The real issue is matching borrowers with the wrong loans
Did you know that negative amortization loans were around years before they were popular with Countrywide, WaMu, and World Savings? That is right. Various S&L's would carry such products. So why is it that these loans can be around for years and NOW we are getting crushed by them? Because more recently they were given to the wrong people (Wrong tool, wrong borrower, wrong age, wrong financial understanding level).
When you give a first time buyer an interest only loan at 100% financing that has a rate that adjusts after only 2 years, you are creating a serious mess. When you give a negative amortization loan to a borrower that can barely pay the 1% payment rate (but is really being charge 7% - which the loan will later adjusts to), you are creating a serious mess.
These loans got riskier and riskier. As homes appreciated, people that failed with these loans simply listed and sold their homes in a week. All is good. Until appreciation stopped and went in reverse.
Interest only loans in and of themselves are not bad loans. For a financially savvy home owner, an interest only loan that adjusts monthly can be a God send, because they understand finances. (Right tool - right user).
Putting a knife in the hand of a 3 year old is just like lending an interest only loan to the financial noob. It may just be a miracle if things turn out right!!
Steve Kappre is a mortgage loan officer in New Jersey. For more info or questions feel free to contact Steve.
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Steve, well put. And thank goodness we don't give knives to 3 year olds!!
Jeana - It is a good thing! Maybe banks should have considered such "silly" analogies?
I can agree Steve but if no- interest becomes freely available will the wrong borrowers be matched up again....and will uniformed borrowers take advantage again....
Dennis - That's pretty funny. Like if a no interest loan was available but it was a 5-year term ... (ok now that's just silly ...)
The type of loans are good for the financially responsible and those that have some money behind them. They work well for the person that knows they can get a better return on their money elsewhere.
Bill - Exactly.
Steve....all loans are only good for the financially responsible!!! when interest rates were in the high teens and low 20% range, 40 year negative amortization loans worked but only for the financially responsible....if they did not refinance to a fixed rate, they would have had problems in the future....they needed to maintain a good credit rating to do that.
Steve..Sorry I think these loans are the loans that helped wrecked our economy
Barbara - Having a plan in place from day one is very important.
Hannah - Some say it was REALTOR'S fault for our wrecked economy ... should we get rid of all of them??? Some bad agents don't make all agents bad. And because the right loan went to the wrong people doesn't make the loan bad.
... I hate noobs ... and no, knives and 3 yr olds = never good ...
Is it wrong that I cracked up when I got to the part about 15 year olds being tools?
Lisa, little do they know it but most 15 yr olds are tools!:)
Steve spot on brotha- I used to always use this example. The wage earner with an extensive history of generous year end (or other periodic) bonuses. I put so many of them into interest only loans then got them to commit to paying a certain percentage of their bonuses into principle each year. It was a perfect solution, increasing monthly cash flow and usually increasing principle reductions versus a 30 yr loan!
Tools are meant to be used, but only in the right hands!
Gerry Suarez, Jr.
Your FHA Loan Pro!
Gerry - The fact is the majority of my clients couldn't get steared this way. But the handful that listened and utilized this product had $$ for a raining day, could pay their mortgage when they lost their job, and even invested for their future.