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Key factors to consider on interest-only mortgages
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Don鈥檛 call it a comeback.
Interest-only mortgages got a bad reputation in the aftermath of the housing bust, but they鈥檝e managed to stick around as an option for homebuyers who can meet stricter lending guidelines enacted by the government in recent years.
The loans can lower monthly mortgage payments by letting borrowers put off paying the principal on their loan for several years. When the interest-only period ends, the borrower鈥檚 monthly payment spikes as they begin to pay a combination of principal and interest until the loan is paid off.
That monthly payment shock, often accompanied by a higher interest rate on adjustable-rate interest-only loans, is what got many borrowers in trouble a decade ago.
One reason is that many of those borrowers qualified for their loans on the basis of their ability to repay the lower, interest-only payment. When their monthly payment reset higher, many couldn鈥檛 keep up.
That鈥檚 no longer the case. Now lenders are required to determine whether borrowers qualify for any interest-only loans, or other adjustable-rate mortgages, based on whether they can afford to make the eventual bigger monthly payments that await them once the initial interest-only period ends.
As a result, such interest-only loans now make up only about 0.2 percent of all adjustable-rate mortgages, or ARMs, which account for about 4 percent of all home loans for purchase and refinancing, according to data from CoreLogic.
Use of interest-only mortgages peaked 10 years ago at the height of the housing bubble at around 10 percent of all ARMs.
鈥淭he big difference here is interest-only loans are back to being the niche product that they traditionally had been,鈥 said Greg McBride, chief financial analyst at Bankrate.com. 鈥淭he go-go days of the housing boom were the exception.鈥
Still, rising home prices can make interest-only loans a tempting option for borrowers who are interested in a lower mortgage payment and can qualify for such a loan under today鈥檚 stricter guidelines.
At least one lender is looking to expand access to interest-only loans to a broader range of homebuyers, not just the affluent buyers who typically take advantage of such loans.
In July, United Wholesale Mortgage began making interest-only home loans through its network of mortgage brokers. The loan program covers mortgages as low as US$250,000. That鈥檚 just above the US median home price of US$236,400, but well below the recent median price in Southern California of US$426,000.
Even with today鈥檚 stricter guidelines aimed at ensuring borrowers can handle interest-only loans, they carry potential financial risks.
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