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Interest-Only Interest

Interest-Only Interest


“Interest-only” mortgages might be making a comeback, at least on a limited basis.  These loans require the borrower to pay only interest for a set number of years before the payment adjusts to allow for payment of principal, too.  They enjoyed heightened popularity about a decade ago in the midst of steadily-increasing home prices, and were often found as a feature of adjustable-rate mortgages (“ARMs”), many times with low down payments.  A lot of borrowers were qualified for these loans based on their ability to afford the initial payment, not taking into account the possibility of payment increases from interest rate increased nor the certainty of payment increases from the loan entering a period of principal repayment.  Some of these loans even allowed the borrower to make such a low payment that the loan experienced negative amortization, meaning that the principal balance actually increased over time.

When the mortgage crisis hit the United States, home values began falling, leading many of these borrowers into foreclosure because they became unable to make the payments and had little or no equity in their homes.  As could be expected, these risky types of loans plunged in popularity.

Now, however, some lenders are seeing an uptick in interest-only loans, but subject to much stricter lending standards.  For example, a minimum down payment of 20% of the home’s value is required and the borrower must have good credit, generally a FICO score of 720 or higher.  Qualification is based on the amount of the eventually amortized payment, which cannot exceed 42% of the borrower’s income.  Payments of principal begin after 10 years, and the borrower’s income must be verified – no more “no doc” loans.  Because of the additional risk to lenders, the applicable interest rate tends to be higher, maybe by a full percentage point, than for a “conventional” loan.  These loans may be attractive to certain sophisticated and relatively well-off borrowers, and will probably grow in popularity over the next few years (at least until the next housing market crash), but are still only a small fraction of the half trillion dollars of such loans originated in 2006.

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