Surprisingly, Interest-Only (I/O) loans are back. They carry higher interest rates than fully-amortized (principle & interest) loans, but recently, they have become quite competitive. I’m surprised that they’re available because these loans are a big reason why our housing market deteriorated. The combination of a 5/1 Interest-Only loan coming due at a time when housing prices reduced meant (means) that people cannot refinance into a new loan. This is what had caused people to default on their mortgages: no lender would lend to them because there was no equity in the home, and then concurrently, their monthly payment skyrocketed, since they were going from an Interest-Only payment to a Principle & Interest payment over a shorter term.
But now that the I/O option is back, lenders have a few caveats:
- The person must be able to qualify at the fully-amortized payment, not the Interest-Only payment, which is generally hundreds of dollars less per month.
- The Interest-Only payment option is extended to ten years, regardless of the Fixed Term for the ARM. So whether you choose a 5/1, 7/1 or 10/1 ARM, you have the I/O option for 10 years.
- You must have 25% equity in the home (some lenders may allow less, but 25% is common).
ARMs can still be a smart financial tool for the right person, but definitely not for everyone (or many at all, actually). It depends on your financial profile and risk comfort, but more importantly, that you are going to hold yourself accountable to actually utilize that monthly payment savings through other financial investments that pay you more than the interest rate at which you would be paying your mortgage.
