Mortgage 'Perfect Storm' Brewing?
In the midst of the current
But The Early Show financial adviser Ray Martin warns many people are playing with financial fire when they choose that option.
He explains that interest-only mortgages are typically adjustable-rate loans in which the borrower pays interest only for a specified period of time.
"The attraction here for home buyers," Martin observes, "is that, all things being equal, an interest-only mortgage can be hundreds of dollars less per month in the initial payments."
But, he continues, problems could crop up later.
He cites a $300,000 loan as an example.
At a fixed rate of 5.88 percent, a common 30-year fixed rate, interest-and-principle mortgage would require a monthly payment of $1,738.
But with an interest-only plan, it would carry monthly payments of only $1,335 at first, but those would jump to $1,933 when principle starts kicking in after six years.
Martin says he sees two risks in interest-only mortgages.
"First," he says, "is the payment shock. After the initial interest-only period, two things will happen that will increase payments 40 percent to 70 percent.
"One is your interest rates will rise. Interest rates are on the rise and adjustable-rate mortgages will see higher interest payments."Second is, you're going to have to begin repaying principle in three to five years. Your payment can go up 40 percent to 70 percent.
"The other risk is a more sinister risk. You're not paying down any principle with this mortgage. If you have to sell the home in a short period of time, you're not going to have any equity buildup.
"People say, 'Hey, Ray, I'm going to grow equity, because my house is always going to appreciate.' But, if your home doesn't appreciate, you haven't paid down any debt, so if you go to sell that home, you could have to write a check at the closing table to sell it."
Interest-only mortgages are leaping in popularity, Martin points out. In 2001, only 1.6 percent of mortgages were interest-only. Now, it's almost a third. And the numbers are even higher in some of the hot housing markets, where people are "stretching just to try to buy that house at that high price."
"I think there's a perfect storm forming here," Martin warns. "People are buying homes with these interest-only mortgages.
"The number of people paying 50 percent or more of their income towards a home has gone up 76 percent over the last five years. And if people are using this product to buy a home, stretching to buy it, and they get that payment shock and can't hold onto that home, they might say, 'Well, I'll sell it.'
"And if a lot of people using interest-only rate mortgages are in the same position, and they all go to sell at the same time, you could have a serious price decline pushdown from people here. And walking away from a home means foreclosure or bankruptcy, and the new bankruptcy laws make that a lot more difficult.
"It could be a perfect storm. It's a dangerous product in the wrong hands."