- The Washington Times - Thursday, November 10, 2005

In the last 24 months or so, there has been a lot in the news about interest-only mortgages. A loan that carries an interest-only feature allows the borrower to pay just that — only the interest charged for the month for a specified term.

These products have gained huge popularity. After poking around the Internet, I found some interesting statistics as reported by a variety of institutions:

• Nationwide, the percentage of interest-only loans originated jumped from 6 percent in 2002 to 31 percent in 2005.

• 47.30 percent of all mortgage loans in San Diego carried an interest-only payment option in 2004.

• In 2004, 50.40 percent of all purchase money loans in Georgia contained an interest-only payment feature.

These statistics should surprise no one. We can attribute the popularity to three things.

First, interest rates have remained low. Borrowers don’t see the logic in paying down a debt that is so cheap and in most cases, tax deductible. The antiquated wisdom of paying off the mortgage and owning a home free and clear by the time you reach retirement has long gone by the wayside.

Second, property values have soared. Homeowners figure that paying down principal isn’t necessary because home prices keep rising. Why spend your hard-earned money building equity by paying down a loan when the equity is growing by itself through appreciation?

Affordability is the third reason interest-only loans have become so popular. Soaring property values is a double-edged sword. It’s terrific if you bought a home in the late 1990s when the average time a property remained on the market exceeded six months. Buyers today get carted around on a Sunday afternoon looking at listings only to faint when they see the prices.

In a market that heavily favors sellers, buyers have resorted to more creative financing techniques in order to afford the house they want.

This is why interest-only loans have gained popularity: Folks can buy a bigger house if the monthly payment includes no principal.

Consider the following: A $400,000 loan at 6 percent amortized over 30 years requires a principal and interest (P&I;) payment of $2,398 per month.

The same terms with an interest-only payment drops to $2,000.

Let’s look at it the other way. A $2,400 monthly payment allows a $400,000 loan if the loan is amortized over 30 years.

A $2,400 monthly interest payment allows you to borrow $480,000. Having the ability to borrow $80,000 more with the same payment will buy you a lot more house.

Now that the hot real estate market appears to be cooling off and interest rates are on the rise, will the interest-only fad fade? Who knows? However, the folks who buy at the peak in the current cycle in hopes of making a quick buck could be in store for a rude awakening, regardless of the type of financing.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@pmcmortgage.com).

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