Home Buying
Are interested-only loans principally risky
By Kathy Bushouse and Robyn A. Friedman
Sunday, June 19, 2005
In the rush to get a piece of South Florida real estate, many buyers and investors are stretching financially to buy houses that they otherwise might not be able to afford.
Increasingly their financing method is interest-only loans. For example, Robert Freeman of West Palm Beach, publisher of the monthly newspaper New Business Today, used these loans to buy condominiums and townhouses.
"Interest-only financing gives me more leverage," Freeman said. The holder of an interest-only mortgage pays less initially per month than someone who has a traditional mortgage.
The use of interest-only loans is exploding: Almost one-third of all U.S. home buyers last year chose this kind of financing. Lenders say such loans can help people buy bigger, more expensive homes. They also can make sense for investors who hold properties for short periods.
But some analysts and federal regulators warn that, if a suspected housing bubble bursts, such loans could help push homeowners into foreclosure and pose a risk to banks, which may not be able to recover their money.
"The biggest problem prior to all this money being available was getting a buyer qualified," said David Dweck, a real estate agent in Boca Raton. "Now, if you can fog a mirror, you can buy a $500,000 house."
Some say the structure of interest-only loans invites trouble. Homeowners typically pay off these loans over 30 years -- the same as with a conventional loan. But for a period of time -- often five years -- a borrower can choose to pay just the interest on the loan.
The problem: After that interest-only period ends, homeowners must start paying down the principal, along with the interest. The interest rate for such loans is usually not fixed, but rather adjusts according to market conditions. Couple that feature with a likely future increase in today's historically low interest rates, and buyers could find their monthly payments nearly doubling in a few years.
Federal Reserve Chairman Alan Greenspan expressed concern last week about interest-only loans in remarks to Congress' Joint Economic Committee.
"To be sure, these financing vehicles have their appropriate uses," Greenspan said in his prepared testimony. "But to the extent that some households may be employing these instruments to purchase a home that would otherwise be unaffordable, their use is beginning to add to the pressures in the marketplace."
For example, the loans are seen as further inflating home prices. In Florida, housing prices rose 21.4 percent for the first quarter compared with last year. Prices have not cooled off, as some experts expected. Financing methods like interest-only loans are partly to blame, some say, because buyers can bid higher and afford more expensive houses.
The number of these loans has soared. In 2001, only 1.6 percent of homes sales nationwide were financed by interest-only loans, compared with 31 percent last year, according to figures from LoanPerformance, a San Francisco firm that compiles and tracks mortgage data.
In South Florida, 31.2 percent of home sales in the Fort Lauderdale metro area -- more than double the rate of the year before -- and 37.6 percent of home sales in the West Palm Beach/Boca Raton area were financed by interest-only loans.
Customer demand is driving banks to offer new and different mortgage products, from interest-only loans to granting borrowers 40 years rather than 30 to pay off their fixed-rate loans. The new products allow more people to qualify for loans.
Homeownership has reached a record of 69.1 percent in the first quarter of 2005,
up from 64.2 percent for the same period in 1995, according to U.S. census data.
