Interest-only loans return: Is that good or bad?

Interest-only loans return: Is that good or bad?

Jan. 9, 3015 – Interest-only loans, once blamed for the subprime mortgage crisis, are gradually re-emerging. But the product has changed a bit, which may ease some industry fears about their comeback.

As home values rise, borrowers and lenders’ confidence in interest-only products has grown once again, Guy D. Cecala, CEO and publisher of Inside Mortgage Finance, told The Wall Street Journal.

With interest-only loans, borrowers make monthly interest payments but pay nothing toward the principal for a set period of time. The majority of interest-only loans today are geared toward wealthy borrowers and centered at the jumbo-mortgage level. Jumbo loans exceed limits of $417,000 in most areas or $625,000 in high-price areas.

“Most lenders think interest-only mortgages are very safe because the borrowers have strong credit profiles and generally put down large downpayments,” Cecala told the Journal.

Prior to the housing crisis, lenders mostly qualified borrowers for interest-only loans based only on their expected interest payments. However, lenders today qualify borrowers based on their ability to pay both interest and principal, says John Walsh, president of Total Mortgage Services, based in Milford, Conn.

Walsh says that on a $1 million, seven-year ARM with an interest rate of 3 percent, the monthly payment for the first seven years would be $2,500. However, the lender would calculate the borrower’s debt-to-income ratio using a $5,020 monthly payment of interest and principal at the starting rate.

Mortgage rates stayed low in 2014, even inching below 4 percent for the 30-year fixed-rate mortgage, but rates are anticipated to rise this year. If landlords raise rents, interest-only loans likely will grow as a more desirable option to homebuyers, says Cecala.

The lower monthly payments from interest-only loans may be particularly appealing to borrowers who have shifts in seasonal incomes or who plan to sell other property or want to keep cash in higher yield investments, says David Adamo, CEO of Stamford, Conn.-based Luxury Mortgage.

Source: “Interest-Only Loans Set the Bar High,” The Wall Street Journal (Jan. 6, 2015)

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