More Interest in Interest-Only Loans

It sounds a little preposterous at first, like one of those promises during a late-night infomercial: Pay only the interest for the first one to ten years, and allow yourself to get into a home. (Or, get into a larger, more expensive home now.)

Yet, interest-only loans are fast becoming a favorite among new homebuyers, thanks to the flexibility they offer. In essence, the purchaser becomes a homeowner right away, garnering all of the tax breaks that go with home ownership, yet has five years to make higher payments, refinance, or earn additional money to meet the then-higher mortgage.

Mortgage broker Kevin Casey says the interest-only loans are ideal for families who want to move up, but don't feel they can do so. "There are a lot of people who feel trapped in their homes," he explains. "Maybe they bought their home, a smaller, starter home, for $250,000 or $300,000 some time ago. They're now busting out of that home, but when they go to look at the homes they want, those homes are going for $600,000, maybe $700,000, or more," he explains.

In this situation, Casey says the interest-only loan gives the growing family some options. "Let's say you have a couple with a home now worth $300,000. They sell that home, and apply the equity to their newer, $800,000 home. They also take an interest-only loan for the remaining $500,000," he says.

What happens once their new, move-up home is purchased? Casey says that will depend on several factors. "If rates go down [in the five-year interest-only period], they can refinance. And that happens very frequently - most homeowners will refinance within five years, so why lock yourself in for 30 years when you will refinance anyway?"

But the interest-only scenario still makes some purchasers a bit nervous, so Casey also looks at what he calls the worst case scenario - which is still not too bad. "First of all, they have had five years to earn more money, and save, if they choose. They have also had five years of tax savings. That being said, if they haven't refinanced, they can change over to another loan program, with some flexibility, for several more years, and wait for rates to fall."