Home Buying
Interest- only loans soar
by
Ryan Geddes
The Business Journal of Jacksonville
The frenzy of home building
and buying in Northeast Florida over the past year has given rise to a new type
of home loan that allows borrowers to pay only on their mortgage's interest for
the first 10 years.
The mechanics of these interest-only
loans vary from bank to bank, but their popularity is soaring, and lenders in Jacksonville
are planning to roll out more versions of the suddenly popular products in the year
ahead.
"We've seen an incredible increase in these in the
last three months," said Stu Williams, executive vice president of SunTrust
Banks Inc.'s mortgage line in North Florida. "I think it's a consumer trend we're seeing
today to minimize the cash outflow to the home."
The loans, usually set at an adjustable rate or
a staggered fixed and adjustable rate, are structured to provide borrowers with
the lowest possible payment for the first part of the loan period. Then, usually
10 years after the mortgage is made, the borrowers start paying on the principal.
As a result, homeowners have more cash on-hand to put to other uses for the first
10 years after they take out the mortgage, but their opportunity to build home equity
is reduced.
In a market in which home values are rapidly increasing,
that might not be a problem. But if the market sours, homeowners could lose money.
"Say at the end of 10 years the home values have
decreased. Then at the end of that time you will have no equity in your house and
you literally could be writing a check at closing," Williams said.
In addition to market values, much of an interest-only
loan's performance is based on interest rates, which hit rock bottom in 2003. Low
rates made it easier for buyers to afford homes if they locked in the low rates,
but many interest-only loan products are tied to variable rates.
One of those rates is the London Interbank Offered
Rate, or LIBOR, a popular reference rate for short-term interest rates based on
the London inter-bank market. The rate has been popular for years as a reference
for commercial loans, but has only just become common as a benchmark for residential
mortgages.
The LIBOR rate is commonly low and slow to rise
when it does go up, making it attractive for those who don't mind taking a risk
with an adjustable-rate home loan.
"A lot of people are conservative and do not want
their rates to change. Now that we're at an all time low [interest rate], people
want to lock in and be safe," said Pam Shore, vice president for SouthTrust Mortgage
Corp. in Jacksonville. "In the past, I would
say I would not sell this [interest-only]
product to a person on a fixed income, but now those people are coming in and refinancing
on it. Maybe they are selling their home or moving into a retirement home and wanting
to make interest-only payments."
From an investment standpoint, the interest-only
mortgage is essentially a bet on property appreciation, not always a sure thing.
Although the loans might make it possible for borrowers to afford larger homes than
if they borrowed traditionally, the risk is higher.
"A house is not something that you risk," said Howard Dvorkin, president and
founder of Consolidated Credit Counseling Services Inc.,
a nonprofit debt counseling organization based in Fort Lauderdale. "The fact is
that people are missing the opportunity to lock into a long-term rate that has been
the lowest in 40 years and, as such, taking a chance when the only place these mortgages
are going is up."
Not all banks offer interest-only loans, and not
all of the ones that do are targeting the average homebuyer. At Compass Bank the
loans have recently been popular with executives with high incomes and a penchant
for relocation.
"We see this product as requiring a certain level
of sophistication and understanding," said Bob O'Reilly, senior vice president at
the Houston-based bank. "You want to make sure the borrower understands the circumstances."
