Tuesday, April 12, 2005

Riskier loans stir up interest


Interest-only mortgage not all bad, but buyer beware
JONATHAN LANSNER
Register columnist


The gap between owner and renter is slimmer than you think.

One benefit of home ownership is increasingly passé - so-called "building equity" by systematically reducing a mortgage's balance.

Slightly more than half of last year's buyers of Orange County residences utilized mortgages that contained interest-only provisions, according to LoanPerformance, a loan-tracking firm from San Francisco.

Many interest-only deals let borrowers skip paying down their loan balances for the first two years to five years of a mortgage. Other deals - so-called "option" mortgages - let borrowers choose whether to pay down the loan balance.

These opportunities to prune monthly payments were an alluring choice last year. Interest-only loans basically doubled in frequency in Orange County. As recently as 2001, these loans comprised a mere 3 percent of mortgages used to buy local homes, says LoanPerformance.

We're not alone. Interest- only loans are popular across the state (47 percent of California buyers used them last year) and the nation (31 percent.)

Yet in our county - where a modest home runs you a half-million bucks - shaving pennies on mortgage payments is art.

By my math, a common interest-only loan, when used to buy a mid-market O.C. residence, saves the borrower inthe ballpark of $500 a month on the initial payments. Assuming usual loan-qualifications standards, interest-only savings could let a person spend at least an extra $100,000 for a house.

People have this antidote to sky-high home prices because bankers are bending tradition.

Some experts worry about such loans. Early discounts - cheap starting interest rates and not paying down the loan - end abruptly in as little as two years. If rates continue upward, interest-only borrowers might get a rude shock to the wallet.

But LoanPerformance's Mark Carrington says there's no proof so far that interest-only borrowers are more prone to miss payments than folks with traditional loans.

The usual interest-only deal provides a healthy financial cushion for lender and borrower, LoanPerformance reports.

Just 15 percent of interest-only buyers nationwide last year used a down payment smaller than 20 percent of the home's value - a critical level for loan soundness. For all other mortgages, such smaller down payments were in 36 percent of the loans.

Borrowers like interest-only deals, Carrington says, because "they're looking at monthly payments, very similar to how they buy a car, rather than looking at the total (mortgage) deal."

SPREADING THE WEALTH

Do you really want to own your home free and clear?

It's a noble notion - from another era when homes represented a modest slice of a household's net worth.

Astronomically high home prices turn interest-only loans into a reality check.

Think of the classic O.C. buyer who's moving up from a smaller residence and bringing a pile of old home profits to the latest deal. This tidy sum helped create the typical countywide down payment of $126,000 at latest count.

That's plenty of money tied up in one asset, so you could look at interest-only loans as a financial-planning tool.

Imagine a fortysomething couple buying the typical half-million home. Do they really want to pay offtheir mortgage in full - ever?

Imagine homes appreciating at 3 percent - the historical inflation rate - over the 30-year life of a traditional mortgage. Having no mortgage payments is a nice goal, but would this fortysomething couple live in retirement without tapping into a home valued around $1.2 million?

If a home gains an average 6 percent a year - the historical local appreciation rate - it's a $3 million place in 30 years. Would this fortysomething couple want to leave that much money to the children?

If you're honest with yourself, you realize you'll probably borrow again against your home - or sell it to downsize later in life.

So it's logical to ask: Why kill yourself financially to pay off a mortgage?

JUGGLING ACT

Savings that are forced upon borrowers as they pay down a mortgage balance over the years are a crucial reason why the average family does so well financially by owning a home.

Such a fiscal regimen is needed by numerous folks.

With an interest-only loan, some people might simply squander the savings. Others will use the added borrowing power these loans produce to overpay for properties.

Interest-only deals might give borrowers false comfort by delaying the brunt of the high cost of housing.

But I'm not saying that all people using interest-only products are fiscally irresponsible.

Paul Creason's family bought a Lake Forest home for $300,000 four years ago with an option mortgage.

He admits that "some months I didn't have what I needed" in the bank, so he paid only interest due - a blessing in a home with three kids.

Last summer, Creason refinanced into a fixed-rate loan with no regrets about the interest-only deals.

"It ended up being wonderful for our family," he said.

Interest-only loans are fueling local housing passions. You cannot ignore pressures that many folks feel to grab their own piece of The O.C.

Buying a home is a thorny financial challenge for many folks, without their mortgage potentially tossing the household a curveball or two.

No matter the environment, it's still "Borrower Beware!"

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