Interest-only mortgages remain popular

A shift in real estate from a sellers’ market to a balanced market, with more homes for sale at a slower pace than over the past four years, influences the financial decisions consumers make when purchasing a home.

Concern about a potential increase in interest rates also impacts decision-making when it comes to mortgages.

In recent years, many buyers faced with the rapid rise in home prices in the Washington area turned to interest-only mortgage loans that can offer lower monthly payments during an initial period of just interest payments.

Financial experts grew concerned about the possibility of borrowers having difficulty making the payments for their homes when the interest-only period of the loan ended, particularly when the loans carried an adjustable rate and interest rates were rising.

Despite this concern, interest-only mortgages remain the most popular loan product in the Washington area. But while interest-only loans started as an adjustable-rate loan, the most popular versions these days have a fixed rate.

“The most appealing loans now are fixed-rate loans for 30 years, with interest-only payments for the first 10 years,” says Barbara Roubo, branch manager of Accubank Mortgage in Fairfax, a division of National City Mortgage.

“The principal on the loan is paid during the last 20 years of the loan, so the payments definitely go up after 10 years, but at least borrowers know ahead of time what their payments will be,” she says. “You don’t get what I call the double whammy of adjustable interest-only loans, which had the guarantee of a larger monthly payment for the balance of the term from amortizing the principal, and the potential for a rate increase as much as 5 percent.”

Bob Gill, branch manager for First Horizon Home Loans in Centreville, says fixed interest-only loans are also popular with his customers.

“People like not having to worry about a rate change for 10 years,” Mr. Gill says. “But they need to be aware that there’s quite a comeuppance at the end of 10 years, with an increase in the payment of one and a half or two times. A lot of people will probably want to get out of it at that time by refinancing or selling the home.”

Mr. Gill points out that with the difference between an adjustable rate loan and a fixed-rate loan currently as little as 1/4 percent, very few borrowers opt to accept the risk of an interest rate increase.

“Some people are still opting for an adjustable-rate loan if they know for certain that they are only here for a short time, such as military personnel,” Mr. Gill says. “Some people also know they will sell their home at a certain time because they have kids going to college or for some other reason, and then it can make sense to take the additional savings of an adjustable-rate loan.”

Phil Drew, branch manager for Carteret Mortgage in McLean, says he believes the 30-year fixed-rate interest-only loans offer a very secure program for most consumers, particularly because in the Washington area most people stay in one home for only five to seven years.

“The only downside is that during the last 20 years you have to make a higher payment than you would have had with a straight 30-year loan,” Mr. Drew says.

“But it’s not that big of a bump, especially if you assume that your income will rise over the years,” he says. “If your income just keeps up with the cost of living, then as a proportion of the budget the payment should be acceptable. That’s assuming you could only qualify for the loan with interest-only in the first place. A lot of people want the lower payments of the interest-only loan but could qualify for the fully amortized loan anyway.”

Mr. Drew reviews the payment schedule with his clients for each of the 30 years of the loan. But even when working with a lender who does not go over the payment schedule verbally, consumers can see the new payment on the truth-in-lending papers at the settlement.

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