The
Loan du Jour
Many
restaurants have a Soup du Jour. Regular customers
want to something new on the menu, so it’s a nice
way to pique their interest, even if they expect
clam chowder on Friday. The mortgage industry
seems to do the same thing, coming up with something
different at regular intervals, although not on
a daily basis. In the last 23 years I have seen
dozens of these come and go, and only a few good
ones have stayed. Most have faded into the sunset,
and properly so.
Almost
invariably, lenders’ have a lot of marketing hype,
tout the loan as “new” and “improved.” But they
really are designed to be bright, shiny lures to
help the salesmen troll for unsuspecting clients.
Also these products are almost always something
that earns the lender a little more of your hard-earned
money without your suspecting you’ve been had.
The
current Loan du Jour is the Interest-Only
loan. These have been widely available as equity
lines of credit for years, but some lenders are
now offering regular fixed rate mortgage loans with
this feature. Is this a good deal or just another
scam?
First
it’s important to look at how much of a difference
this can make. We’ve all become used to higher interest
rates, where only a small portion of the payment
on a 30-year loan goes toward principal. With
a loan at a rate of 8 percent, only 9 percent of
the payment goes to principal. With a 6 percent
loan, the percentage rises to 17 percent, and at
4 percent, a whopping 30 percent of the payment
goes to principal reduction. Lowering the payment
by 30 percent is a large drop. On a $200,000 loan
at 4 percent, the payment drops from $955 to $667.
Is this good?
The
other argument is that with a lower payment, borrowers
will qualify for a larger home. The downside of
that is that means more debt, and that may not be
a good thing. These days our industry will bend
over backwards to help people buy a home, routinely
approving loans with very high qualifying ratios.
If we go beyond our current very liberal limits,
we’re saddling people with even more debt. I don’t
think we’re necessarily doing them a favor.
I
also believe that it is important to build equity
on a home, something that does not happen with an
interest-only loan. If homebuyers are making only
a small down payment, like 5 percent, when they
sell it the sales commission alone will wipe out
that equity. That leaves them just whatever equity
resulted from appreciation, perhaps less than they
thought it was going to be.
If
you wonder why the industry is doing this, consider
that their profits are maximized if they can keep
you in hock for the longest period of time. If
they can get a couple of million people in loans
like this, they can make more money than when the
loan balances go down every year. Paying
the minimum amount due each month is the dumbest
credit card policy, so why would it be a smart thing
to do with the mortgage? Answer: it isn’t!
Is
this appropriate for some people? Sure! It’s an
ideal loan for someone who buys fixer-uppers and
sells them quickly after renovation. Equity build-up
isn’t a factor if the ownership period is that short.
It also might be a good loan for an older person
with a small loan and lot of equity. Having extra
money to have fun with every month may be more important
than leaving the heirs a house that’s paid for.
What do they care; they are just going to sell
it anyway.
One
final word of caution: with most of the programs
I see, the lender actually charges a higher rate
of interest on interest-only loans, typically from
one-eighth to one-quarter percent more. They don’t
advertise that of course, so you have to ask what
the rate is on an amortizing loan and then compare
it with what their rate on an interest-only loan.
Be
careful out there!
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