Once upon a time, one of the most popular mortgage products being offered by lenders was the “interest-only” loan. Its popularity was simple to see; a borrower could get into a much more expensive home than he normally could have because he was qualified only on whether he could make the interest-only payment.
My, how times have changed. Talk about a product that has been put in the doghouse.
Along with negative amortization loans and other silly products that Wall Street dumped into the marketplace to woo potential homebuyers, these interest-only loans were delicacies.
They came in 3-year, 5-year, 7-year and 10-year varieties. Or you could get a 30-year term where the first 10 years you could just make the interest-only payment. One of the seller features was that you could tell the borrower that they could control their cash flow much better by either paying the fully amortized payment or the much lower interest-only figure.
And to see why they were wildly popular, just look at the math.
Let’s say a borrower was looking at a $500,000 home. With a 20 percent down payment, the loan amount would be $400,000. And let’s say that the borrower’s total gross monthly income was $6,000 a month.
Back in 2005, the 30-year fixed rate hovered around 6 percent. Therefore the principal and interest payment would be $2,398 a month.
Rates for an interest-only loan typically are higher. Therefore, let’s use 6.25 percent. But to figure out the payment on interest-only loan, you take the loan amount, multiply it by the interest rate and divide by 12.
Now the interest-only payment for the same loan amount is $2,083, a savings over the amortized rate of more than $300. That could be someone’s BGE bill. Or a car payment.
But what it wasn’t doing was paying down the loan. That’s fine if values are going up, but when values crashed after 2007, interest-only loans crashed as well.
Nowadays, you can still find them out there, but the guidelines are so restrictive only the most well-heeled borrowers can take advantage of them.
First, most lenders will require a 30 percent down payment, or for a refinance 70 percent equity in the property. For best pricing on an investment property, lenders only require 25 percent down payment.
Next, borrowers are qualified on the fully amortized principal-and-interest payment, plus taxes and insurance. And again, rates today for interest-only loans are much higher than non-interest-only rates. So qualifying is more stringent.
Finally — and here’s the real kicker — the amount of reserves borrowers must have in their asset accounts after the transaction is substantial. Most lenders will require 24 months of principal, interest, taxes and insurance payments. So that means if the PITI payment comes to $3,000 a month, the borrower must have $72,000 in savings or retirement funds at their fingertips.
One lender, in fact, has a restriction that borrowers must have minimum household income of $150,000 and $250,000 in reserves. In other words, we have the product, but we really don’t want to sell it.
So what lenders are basically saying is that we only want well qualified, sophisticated borrowers to use this product. It is not for the faint of heart. Lenders don’t want to be put in the position of offering a product where the borrower is not paying down the mortgage and then might be vulnerable to another market turndown where values take another drop.
The interest-only loan — a result now of little interest.
Robert Nusgart is a loan officer with Mortgage Master Inc. in Baltimore. He can be reached at 443-632-0858 or by email at [email protected] Visit his website at www.RobertNusgart.com for the latest mortgage and financial news.