- The Washington Times - Wednesday, July 5, 2006

Q: We have a ratified contract to purchase a home and are due to settle in two

weeks. Our ultimate goal is to sell our current residence and use the equity as a down payment on the new home.

There’s no way that we can sell and close on our existing home in two weeks. We have enough money in our savings account for a 20 percent down payment, but the proceeds from the sale of our house will enable us to make a 50 percent down payment, which will keep our monthly payment where we want it.

Our neighbor suggested that we take a bridge loan for the remaining 30 percent and pay it off after we sell our home. Another friend suggested that we take an interest-only loan because the monthly payment will drop after we sell our house and pay down the loan.

I have read that interest-only loans are dangerous and should be avoided.

Any suggestions?

A: The subject of interest-only loans is getting stale in this column, but I find it’s important for me to clarify the facts and dispel the myths of interest-only loans.

The bias in the media about interest-only loans is evident, and your impression of them is not surprising. However, it also is inaccurate.

Over the past year or so, the media has labeled an interest-only loan as a mortgage chosen by financially irresponsible buyers who are using the product to purchase a home they cannot intrinsically afford. Though this might be true in some cases, interest-only loans are terrific products in certain situations.

To recap, interest-only loans allow the minimum monthly payment to be equal to the interest charged for that month. As with a home equity line of credit, making a full interest payment does not curtail the balance, as a 30-year amortized loan would.

The academic media often pairs interest-only products and negative amortization loans in the same pool.

The fact is that these two products are very different. Loans that offer payments with negative amortization, often called “option ARMs,” carry interest rates that are adjusted monthly. The payment may be fixed for five years or so, but if the interest rate rises, the negative amortization increases, causing the mortgage balance to increase even more.

Interest-only loans do not allow negative amortization. The minimum payment is equal to the interest charged, so the mortgage balance can never increase. Moreover, the interest rate on these products can be locked in for a period of five, seven, 10 or 30 years.

Let’s get back to your situation. You friend is right. You should take an interest-only loan and pay it down in one lump sum after you sell your existing residence. A good loan officer can give the options on whether to take a rate that’s fixed for five, seven, 10 or 30 years.

This decision is based on how the rate compares with each product and how long you plan on being in the house.

Either way, taking one loan and paying it down will be far less expensive than taking out a short-term bridge loan. Lenders charge hefty fees for bridge loans because they can’t reap a lot of interest on a short-term loan. An interest-only loan will carry only the closing costs that are customary in your area.

I want to mention one more thing. Remember that interest-only loans merely give the borrower the option of paying just the monthly interest. Contrary to the media’s slant on these products, you can take out an interest-only loan and convert it to a 30- or 15-year amortized loan simply by paying down the correct amount of principal each month.

Any loan officer worth his salt can run an amortization schedule for you and tell you how much more, after the interest payment, you would have to pay.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]


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