Posted on 09/24/2006 11:51:17 AM PDT by ex-Texan
As rates creep up, borrowers with interest-only loans face sharply higher mortgage payments:
Tina Gren Clarence saves $600 a month with an interest-only loan she took out about a year ago for a Petaluma home, yet already is considering heading off the financial hit when her monthly payments could jump.
And Peter Shidler, whose low-payment-option loan could turn from a sweet deal into a potentially bitter one, is refinancing and still will pay $500 more monthly on his Santa Rosa home.
Gren Clarence and Shidler, like two out of three Sonoma County home buyers and owners, joined the fast-growing club of borrowers in high-cost housing markets who financed purchases and home equity loans with low-payment mortgages that explode into much higher payments within a few years.
At first, they don't have to pay a penny on the actual mortgage - and in some cases, don't even pay the full interest cost.
Now, the first wave of borrowers faces a costlier mortgage bill as payments on the popular loans begin rising with higher interest rates.
Some will be in over their heads if they can't afford to pay more. Many others are taking steps to soften or postpone the day of financial reckoning.
Darren Seliga, owner of Seliga Financial, is busy working with clients who need to refinance and figure how to budget $350 to $650 or so more for monthly house payments.
"My job is to find a creative way to get them into something and help them find something different down the road," the Santa Rosa mortgage broker said. "Sooner or later you've got to face the music or sell the house." Shifting financial bedrock
The ritual of creative financing to keep payments low, followed by a new round of financing in an attempt to stay in a home, has become a major part of the North Coast’s home ownership lifestyle. Rare anymore is a home mortgaged once for 30 years and paid off close to retirement. Instead, high housing costs are constantly shifting the bedrock beneath a home that serves not only as a shelter but as an ongoing investment.
“I’m just hoping this all works out for me. It’s always a risk. But you’ve got to take some chances,” Gren Clarence said.
The initial surge of what amounts to delayed-payment mortgages coming due—called “resets” in lender speak — is hitting this year. It will go higher in 2007 before ebbing some in 2008, according to Freddie Mac, the national mortgage company.
“It’s already started. I think it’s going to go for a while because we’ve made so many loans on that interest-only product,” said Randy Blankenbaker, regional manager for Chase Home Mortgage. The reset impact is sizable in Sonoma County and other expensive housing markets where these loans have become popular. They account for two thirds of all purchase and refinance loans in Sonoma County, compared to a quarter of loans three years ago—and have supplanted long-term, fixed-rate loans.
“Sooner or later, they’ve got to pay the true cost of a loan,” said John Klein, branch manager for Charter Funding in Santa Rosa.
Two main options
To avoid the reset hit, lenders say homeowners plan to refinance. Many are choosing longer- term, interest-only loans, others more traditional loans requiring payments toward both a loan’s principal balance and its interest.
Either way, they can count on paying more because interest rates have steadily risen the past two years.
Some will be under more pressure than others. Buyers who recently purchased a home or drew out big chunks of equity could have a tougher time qualifying for a loan, particularly if the home is worth less than the amount of money they owe, given the housing market’s downturn.
A little over a year ago, Gren Clarence was looking for a Petaluma home to shorten the commute to her job as a legal secretary in San Francisco. She decided the low monthly payment of an interest-only loan would help her save money.
Gren Clarence bought a $500,000 home and put 25 percent down. By using an interestonly loan, her monthly payment is $1,640 rather than $2,218 for a fixed-rate loan requiring payments toward both principal and interest.
“That’s how you maximize your savings. Yet you’re gambling,” Gren Clarence said.
Five-year breathing spell
What makes the interest-only loan a good deal in her eyes is a feature that fixes the lower payment for five years. But then the payment goes up to its actual adjustable rate, which for Gren Clarence would tack on at least $600 to her monthly payment.
Even though the reset is more than three years off, she considered refinancing into a longer-term interest-only loan to tap some equity and buy a home in Alameda with her new husband. Instead, the couple will leave the loan alone and finance the new purchase with that old standby, the 30-year,fixed-rate loan.
“Things have changed. We’re making the right decision for this time,” she said. “This is all just cross our fingers and hope it works.”
What changed is that longterm interest rates today are better than short-term ones. With two incomes, they can afford to pay both principal and interest. She will rent out the Petaluma home to pay that mortgage. When the time comes to refinance the Petaluma mortgage, she said there is one loan they won’t consider.
“We’re definitely staying away from those ARM things, anything that creates negative amortization,” she said.
She is referring to option adjustable rate mortgages. These loans offer the choice of an even lower minimum monthly payment and have gained in popularity as interest rates have gone higher. Long favored by wealthy homeowners to invest the savings from lower house payments in the stock market, option mortgages now are offered to more buyers and homeowners looking for lower monthly payments.
“We’re seeing more of those,” Klein said. “The option ARM is good for the investor who uses extra money in another investment that earns more, but not for buying your dream home.”
As a longtime homeowner who sells real estate, Shidler is comfortable with a loan offering four monthly options. They range from a minimum payment that doesn’t even cover interest due to a full principal and interest payment.
“It’s a smart thing to do if you’re responsible with your money,” Shidler said. Shidler used one to refinance his Santa Rosa home five years ago. The $800 a month he saved with the minimum payment went into investments and to buy rental property out of state.
“It was time to start building for retirement,” he said. Two years later, Shidler refinanced again, this time to pull out equity for home improvements. This option mortgage saves about $700 a month.
Loan balance balloons
There is a significant downside to option mortgages. Making minimum payments means a homeowner adds to a loan’s total balance because they are not covering even the interest payment. And that builds faster as interest rates go higher. For Shidler, the first option mortgage added $1,500 a year to the loan. His current one adds $4,000 a year.
“The option ARM was really sweet. But I didn’t like the way it was going up,” he said. “I don’t want to add a huge amount of money to the balance on my residence.” So he is refinancing into an interest-only loan that will be fixed for five years. Shidler’s monthly mortgage payment will increase $500 to $2,000. But, he said, “I can handle that.”
I should have said the editorial did not mention the term "negative amortizing loans." The author did mention the concept in general terms at the end of the article.
Possible cap gain when selling.
It seems to me to be pretty risky to have 2/3 of an areas borrowers in these non-equity gaining loans. I work for a law firm in the NYC metro area and I don't know any legal secretaries who could afford to buy a $500,000 home on their own, even with 25% down. The California housing market really does seem to have become a bubble, based on this article.
gotcha.. thanks!
Yeah, a $125,000 down payment, but with an interest only loan.
We're doomed!!!!!!!!!!
what is so wrong with fixed mortagages? when I looking at my first home arm didnt look good to me then either. I ended up with an 8.5 for 30 years, 4 years later i refi 5.5 for 15
>>What is the difference between an interest only loan and renting?<<
In my case (I rent) about $1,400 a month. That is one reason many see this as a bubble. But I think it is a credit bubble as opposed to a housing bubble. As loans reset, even those who don't lose their homes are going to have an impact on our economy as the money they use to make the higher payments is not used to buy stuff.
"A little over a year ago, Gren Clarence was looking for a Petaluma home to shorten the commute to her job as a legal secretary in San Francisco. She decided the low monthly payment of an interest-only loan would help her save money.
Gren Clarence bought a $500,000 home and put 25 percent down. By using an interestonly loan, her monthly payment is $1,640 rather than $2,218 for a fixed-rate loan requiring payments toward both principal and interest."
In what world does a legal secretary have a $500,000.00 home?
I can see an interest only loan if the property value is expected to rise, but I would rather gamble my money elsewhere.
So it's Bush's fault they financed a house they couldn't afford?
All the while when folks were signing up for these loans, there was a chorus of prople saying they were stupid and dangerous and a bad deal. Well < DING DONG > it's the Piper at the door, and it's time to pay the man.
Perhaps she got the money from the sale of a previous home, or from a divorce settlement.
Given the choice, intelligent people rent.
Exactly! And expecting values to rise much right now might be a big mistake. I just talked to a friend that is in home construction in the Seattle area. He is VERY upbeat but when you really drill him he admits that things have "flattened".
I think of this flattening as what happens to the trajectory of a model rocket when it's fuel has expired and it reaches the peak. It seems to just sort of hover there for the briefest of moments and then...
So...
If you have a $300,000 loan
And that represents 40% of the property value
in an area that's seeing huge ups in the market
would it not make sense to get a 10 year interest only loan
because
your payment is fully tax deductible (as opposed to renting)
and
in 10 years (at 3% inflation)
your loan principal is 1/3 less than it was when you started.
Why exactly is this a bad thing?
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