An interest only adjustable rate mortgage or an interest only fixed year mortgage, allows you to pay only the interest for a specified number of years. After the specified period, which can be anywhere from 3 to 10 years, is over, you are supposed to pay the interest, as well as the principal.
An interest only loan may sound to be very tempting as at the beginning you pay only the interest for the loan and no principal. This can keep your monthly payment very low. However, you cannot have an interest only period that lasts forever, right?
Say for example you take a 30 year fixed rate mortgage where you pay only the interest for the first 10 years. Since in this example, it is a fixed rate mortgage, the interest rate would not change. However, at the end of the 10 years, now you are left with only 20 years to pay off the mortgage that you would have otherwise paid off in 30 years. Also, if the principal had been paid off in the first 10 years, you would have some equity built into the home and you could have refinanced to a lower mortgage at better rates. The monthly payments, when you start paying the principal in the above example, are much higher than what they would have been for a 30 year fixed rate mortgage.
The worst happens when, as it did when the economy collapsed and it has not recovered yet, the value of the homes go down. Since only the interest is being paid in an interest only loan, the principal still stays the same but with the value of the home going down, you technically become “under water” as President Obama calls the situation when you owe more than the value of your home. This makes it impossible or very difficult to refinance resulting in foreclosure and ruining of the credit history that takes a lifetime to build.
The case of the interest only adjustable rate mortgage becomes even more complex. After a certain initial period, even the interest rate increase – which increases your monthly payment even though you do not start paying off the principal yet. When it is time for the principal payments to kick in, the monthly payments go even higher, in fact much higher.
Therefore, it is highly advisable not to fall for the temptations of the interest only mortgages.
Now the point is if it is so risky, why do the banks offer the interest only loans? Well, it was this greed of the banks that led to the collapse of the global economy in the first place. The banks simply wanted to have more and more loans given out and they turned a blind eye toward the repayment capability of the borrowers. The home owners became tempted when there was easy money available and they acting irresponsibly took out jumbo loans which they could never pay. Thousands of people took the interest only mortgages that made their conditions even worse.
Would the new rules from the administration prevent the banks from making the same mistakes again? Well, money can make everyone forget everything. It is very likely that once the economy recovers, the administration would have forgotten to control the banks and the banks would be back to their original ways. For now, all banks are stepping very cautiously in approving new mortgages, but would they in the future – only the future would tell.
