Interest Only Mortgages...

[Garet Jax]

Originally posted by: cpals
I'm trying to figure out a way to afford a house on my income currently and a few people have suggested an interest only loan. Since I'm young and in a stable job currently, I'm hoping that I will be making more money in 3-5 years, but it's still an unknown.

Does anyone have experience with these types of loans and are they 'too good to be true'?

Thanks.

Interest only mortgages are an interesting way to get into a house. It is essentially renting with none of the perks and not owning while having all the drawbacks of owning.

I would recommend using an interest only mortgage for short term things. To generate more cash flow temporarily or so a house can be fixed and flipped.

I do not recommend using it to get into a house for the long term. At a minimum, your house will not appreciate much over the next few years - it may even fall in value putting you upside down.

There are two ways to get into a house on the cheap :

1) Buy a house that needs work. You can get it for much cheaper than if it were immaculate. You can fix it up and artficially increase the value. you still may not be able to find something in your price range. The good thing about this approach is that it is repeatable. You can keep buying, fixing and selling the house always steping up house quality each time.

2) Buy a house with rooms that can be used as bedrooms and rent them out to supplement your income to help pay the mortage. This is the most likely way for you to be able to afford a house.

 

[Slew Foot]

Im probably one of the bigger housing bears out there (having seen prices tank 40% in the early nineties and knowing that the fundamentals are infintely worse this time around), so I would avoid buying a house anywhere for the next 3-4 years. Even in supposedly "non-bubble" markets, you have a surprisingly high amount of people who have cashed out equity from a home in CA/FL/AZ etc.. to buy second or third or investment properties. These will be the first to be put on the market when times get tough and will glut the market in areas you wouldn't normally think. Of course the main bubble markets will prpbably correct greater than 50%, Im already hearing stories in Phoenix about homebuilders offering 30% off original price (D.R. Horton cut prices from $300K--->$219K), and even the Wall Street Journal had an article yesterday warning of 50% price declines.

You have people qualified for I/O loans based upon the initial payment, not the final payments. As had been said before, these usually have low I/O payments for 1 to 5 years, and then reset to inclide the principal, sometimes at a higher interest rate. So people who got loan in the last 5 years are beginning to sell there monthly payments nearly double and maybe triple. I think I read 700 BILLION in mortgage resets this year, 1.7 TRILLION next, and 1.2 in 2008. You usually have to wait about 6-8 months after the resets to see the full effect on the housing market (it takes that long for a foreclosure sale usually). I think the next big buying opportunity will be at the end of 2009-2010.

This is a topic that Ive researched a ton over the last few months so I think I'm more likely to be right than the local Real Estate Agent who always wants some to buy/sell so they can take their 6% cut. I knoe these guys arent unbiased but theyre a good trove of information: http://www.thehousingbubbleblog.com

 

[dullard]

Slew Foot, I agree with you in principle, but I think you are exaggerating the losses. In most housing declines, it seems like a 20% price drop is normal. 50% is probably stretching the truth a bit too much to get a wild headline in a newspaper.

 

[Vic]

A lot of FUD in this thread. There are such things as fixed rate interest only loans. In fact, the OP never even mentioned an ARM, so I don't know why everyone jumped on that fear-wagon. In addition, you can make payments of principal with interest-only loans at any time you want, and any such payment will reduce the minimum interest-only payment (as less principal means less interest to accrue monthly). They're great loans. Very flexible and perfect for the self-employed, those who work on commission, people who expect to come into a windfall in the future, or for young salaried people who expect regular raises in the future. They're also a fantastic alternative to bridge loans. The only drawback to them IMO is that they cost a little more, usually about an eighth or quarter of rate more. The interest-only period is typically the first 10 years, although that can be less in the higher-risk "non-prime" market.

 

[Vic]

Originally posted by: dullard
Slew Foot, I agree with you in principle, but I think you are exaggerating the losses. In most housing declines, it seems like a 20% price drop is normal. 50% is probably stretching the truth a bit too much to get a wild headline in a newspaper.

There is still a tremendous amount of demand in the housing market. Any recent dip in values brings in a new flood of buyers. There are -- understandably -- a lot of people hoping that home prices tank, but most of them are just hoping that so that they can be able to buy in themselves. That alone will prop values up.

 

[iwantanewcomputer]

the fed is done raising rates for now iirc, and we are on the down side of the housing bubble, so in a year or two you should be able to get a much better deal

 

[DougK62]

I wouldn't do anything but a fixed rate mortgage in this housing market.

If you can't swing buying a house in the market you're at, then consider moving. A lot of young, single people own homes in the midwest.

 

[Vic]

IME, people always do the opposite of what they should when in comes to mortgages. The time to get a fixed rate is when rates are low, not high. The time to pay points to buy down your rate is when rates are low, not high.

 

[jlbenedict]

Originally posted by: iwantanewcomputer
the fed is done raising rates for now iirc, and we are on the down side of the housing bubble, so in a year or two you should be able to get a much better deal

There has been speculation that interest rates could again be raised in the next Fed meeting..

Where is this downside of the housing bubble you speak of? This really isn't true.. this depends on the area you live in. In Maryland, housing costs still continue to rise, and has even flowed to the rural areas in which I live. If there was indeed a downward spiral, then housing would drop, which I have yet to see.

 

[dullard]

Originally posted by: Vic
There is still a tremendous amount of demand in the housing market. Any recent dip in values brings in a new flood of buyers. There are -- understandably -- a lot of people hoping that home prices tank, but most of them are just hoping that so that they can be able to buy in themselves. That alone will prop values up.

Yes, there still is a tremendous demand. But the demand is waning a little bit. There is a flood of buyers going in, but that flood isn't quite enough to match the decrease in buyers. In many locations, prices are still going up (just not as fast as they were). However, prices have started to go down locally in some markets.

My little chart page. From that you can see the total homes sold (black curve) has steadilly decreased in the last year (I'm surprized at how linear it is). Home sales are down ~8% in the last year. That to me means a decrease in demand. The median existing home prices peaked in June 2005 and basically held steady. My graph isn't seasonally adjusted, so the dip in the winter was expected. However the entire summer/fall of 2005 showed no net increase in prices.

So, Slew Foot is correct in his principles. Demand is decreasing nationwide, and the soaring prices have stopped nationwide (locally some places demand and prices are still soaring). And every one of those measures has a negative trendline as seen on the graphs. I doubt we'll see much of a pricing dip though, so I disagree with Slew Foot's conclusion on the data.

 

[dullard]

Originally posted by: Vic
IME, people always do the opposite of what they should when in comes to mortgages. The time to get a fixed rate is when rates are low, not high. The time to pay points to buy down your rate is when rates are low, not high.

The length of time you'll be on that mortgage is an even more important consideration than interest rates though. You are 100% correct for the rare buy and hold people. But you are ignoring the rest of the world.

For me, I got a 5-year ARM in 2005. I know that flies in the face of your logic. But it was right for me. (1) I only plan to be in the house for at most 4-6 more years. (2) If I do stay, I plan (and I am on track) to have the house paid off in full by 2014. Thus, even if the ARM rate soars in 2009 (which I planed on in my calculations), the principle balance is minimal at the time and I'm barely affected.

 

[Scarpozzi]

They make sense if you think the housing market is going to rise in your area and you don't expect to be in the house for too long. This is especially the case if rent is higher than the interest payments. Just be sure to factor in closing costs on the loan and figure out what the expected value of the home will be in the future based on surrounding property values of similar condition/size.

I expect I could sell my home for $40k more than I paid for it 2 years ago if I wanted to and could probably find a taker. Find a place that's appreciating like that and you're Gold, Jerry, GOLD!!!

 

[Vic]

Originally posted by: dullard

Originally posted by: Vic
There is still a tremendous amount of demand in the housing market. Any recent dip in values brings in a new flood of buyers. There are -- understandably -- a lot of people hoping that home prices tank, but most of them are just hoping that so that they can be able to buy in themselves. That alone will prop values up.

Yes, there still is a tremendous demand. But the demand is waning a little bit. There is a flood of buyers going in, but that flood isn't quite enough to match the decrease in buyers. In many locations, prices are still going up (just not as fast as they were). However, prices have started to go down locally in some markets.

My little chart page. From that you can see the total homes sold (black curve) has steadilly decreased in the last year (I'm surprized at how linear it is). Home sales are down ~8% in the last year. That to me means a decrease in demand. The median existing home prices peaked in June 2005 and basically held steady. My graph isn't seasonally adjusted, so the dip in the winter was expected. However the entire summer/fall of 2005 showed no net increase in prices.

So, Slew Foot is correct in his principles. Demand is decreasing nationwide, and the soaring prices have stopped nationwide (locally some places demand and prices are still soaring). And every one of those measures has a negative trendline as seen on the graphs. I doubt we'll see much of a pricing dip though, so I disagree with Slew Foot's conclusion on the data.

I won't disagree. My prediction is for home values to flatten out a bit for the next few years. Obviously, the level of appreciation we were seeing could not continue forever. But I don't believe we will see a "bubble," if only because too many people are eager for one to happen.

 

[dullard]

Originally posted by: Vic
But I don't believe we will see a "bubble," if only because too many people are eager for one to happen.

Depends on your defintion of bubble I guess. I've seen the definition to typically say you need these things:
1) Prices to soar.
2) Prices to soar above the fundamentals so that price increases can no longer continue.
3) A period of prices that are steady or falling until #2 is no longer true. In most economic bubbles, the prices fall, but that is not a requirement.

Using that defintion, we definately have a housing bubble. Prices soared, prices got too high, prices are steady (and might fall).

 

[Vic]

Originally posted by: dullard

Originally posted by: Vic
But I don't believe we will see a "bubble," if only because too many people are eager for one to happen.

Depends on your defintion of bubble I guess. I've seen the definition to typically say you need these things:
1) Prices to soar.
2) Prices to soar above the fundamentals so that price increases can no longer continue.
3) A period of prices that are steady or falling until #2 is no longer true. In most economic bubbles, the prices fall, but that is not a requirement.

Using that defintion, we definately have a housing bubble. Prices soared, prices got too high, prices are steady (and might fall).

Typically, a bubble is defined by falling prices and a significant amount of owner negative equity that leads to a dramatic increase in foreclosures, as owners who are unable to sell just walk away. A perfect recent example would be what happened in the manufactured home market about 6 years ago.

 

[Slew Foot]

There arent that many buyers in the market (relative to supply), you can go to an open house in Phoenix and be the only one there all day, and that's an area that dropped as much as any other. I think the amount of buying done by speculators was underestimated and now, without the guarantee of large YOY returns: 1. speculators are dumping their properties 2. Not buying any more. Thus the large rise in inventories weve seen in the last 5 months. Recently, some of this inventory has been converted to rentals (with negative cash flow) as people try to wait out until a better market, which is stupid in my opinion , since i dont think prices will return to where they are for about 6-7 years.

I/O loans are OK in a rising market for certain people, namely those who can expect their income to rise substantially in the next few years. But most MBA students, young physicians, law students, dentists (occupations with non linear income growth) already have homes, and I/O loans are being offered to janitors/Wal-mart cashiers/etc... These people will get creamed as the rates reset. In a declining market, I wouldnt advise anyone to buy, and just wait it out until the market cool. A simple calculation to make is to figure out what rent costs vs. the costs of buying. RIght now in some markets, it's about 50% the buy cost to rent.

And I dont think 50% would be unreasonable becasue 1. that would take you back to the historical moving average 2. We've already seen 10-20% in some areas and the major carnage isnt for another year 3. Its happened before.

 

[dullard]

Originally posted by: Slew Foot
I think the amount of buying done by speculators was underestimated and now, without the guarantee of large YOY returns: 1. speculators are dumping their properties 2. Not buying any more.

Speculators are part of the problem, you are right there. But a lot of the demand was really people in their late 50s/early 60s who just paid off their mortgage, who have tons of money, and who's kids just got out of the house. These people are getting a second home for vacationing. There is no reason to expect this second home boom to end any time soon.

i dont think prices will return to where they are for about 6-7 years.

CNN has an article about that. Housing prices often took 10-20 years to return after a price fall. 6-7 is being optimistic.

A simple calculation to make is to figure out what rent costs vs. the costs of buying. RIght now in some markets, it's about 50% the buy cost to rent.

Rental prices are soaring while housing prices are roughly stagnant. If you rent for 5 years you'll pay more and more each year. If you buy now with a fixed mortgage, 5+year ARM, or most interest-only mortgages, you are at a fixed price for 5+ years. Remember to keep that in consideration.

And I dont think 50% would be unreasonable becasue 1. that would take you back to the historical moving average 2. We've already seen 10-20% in some areas and the major carnage isnt for another year 3. Its happened before.

1) Why do we have to quickly go back to the moving average? Why won't it go back slowly to the moving average. See my crude diagram and discuss. 2) I haven't seen any evidence of 10-20% drops in any local areas yet. Some are in the 5% drop range though. 3) Can you give me examples (I have tons of 20% drop examples, but I'd like 50% drop examples in any form of semi-broad housing market)?

 

[Slew Foot]

Im not sure what the timeline of your graph is but I originally expected to revert to the moving average in about 3-4 years, about the same length of time that it took to build the bubble. Since we are at about 100% of the average now, that would be a 50% decline in current $$, assuming a more historical inflation+1% rise over 4 years this leads to an overall decline of 35% in current dollars. Of course, the bubble central markets (Phoenix, Las Vegas, San Diego, Sacramento, Florida) will likely overshoot into the 40-50% range, while some midwestern cities will decline less.

I see that I misspoke originally, I said 6-7 years to return to where they are, I meant for the next upswing, return to present levels would probably be 10-20 years.

2. Granted I live in Sacramento and my research is done in CA markets since I plan on living here forever. As winter and the slow season comes around, I think youll see an acceleration in price declines.

3. Southern CA early nineties: Parents house(huntington beach) was bought for 205K in 1988, appraised for 280K in 1992, appraised for 195K in 1996. And no one had I/O, option ARM, or other weird mortgages then.

Rental prices are rising about 5%/year last time I checked stats. Buying a depreciating asset(a house right now), without building any equity (I/O, option-ARM, no down loan), and spending twice as much to do so (rent vs. own price difference) is a recipe for trouble.

 

[Vic]

That's because homes don't sell at open houses anymore. Buyers no longer waste their Sundays cruising neighborhoods chasing after for sale signs. Now they shop listings through the internet, and make private appts. to view homes they like.

And yes, the rent vs. buy disparity is starting to close up. After being stagnant for years, rents are starting to go up fast, while in the meantime, mortgage payments are starting to cool off as interest rates and values flatten off. That as well will prop up the housing market.

So. Cal crashed in the early-90s because the defense industry got clobbered.

 

[dullard]

Originally posted by: Slew Foot
Im not sure what the timeline of your graph

I didn't put on on it, it is just random data I drew in Paint. I didn't want numbers on it, otherwise people would think it was real data.

I see that I misspoke originally, I said 6-7 years to return to where they are, I meant for the next upswing, return to present levels would probably be 10-20 years.

Ok I see what you were saying now.

3. Southern CA early nineties: Parents house(huntington beach) was bought for 205K in 1988, appraised for 280K in 1992, appraised for 195K in 1996. And no one had I/O, option ARM, or other weird mortgages then.

Even with that one data point (which isn't broad enough to really say anything), you had a 30% drop, not 50%. 195/280 = 0.7 And appraised values are meaningless. Anyone can get any house appraised for any amount if they try a few appraisers. There is just too much leeway in the process, too much opinion, and too much corruption.

is a recipe for trouble.

Yes, that is a recipe for disaster. But it is a very extreme case. Most houses won't depreciate much, most people will build some equity, and most houses are not truely double the price if you include all factors.

 

[cpals]

Originally posted by: dullard
They are not too good to be true. Why? Because there is no good in them to begin with.

Run far, far away from that idea.

Have you actually sat down and done the math? I know you may or may not like math, but honestly have you done it? What I mean is that you need to answer these questions for yourself (you don't have to post them).

1) What can I honestly afford now? I just paid all my credit cards off right now. The last three or so months I've been putting at least $1300 or more on the credit cards. Now all of that money can be put in the savings to start going for a house.

2) What is the mortgage amount now? Don't understand... I don't have a mortgage right now

3) How much extra will the house cost above and beyond the mortgage? Think repairs, furniture, remodeling, lawn mower, etc. That's another reason I shy towards renting a little more

4) Does (#2 + #3) exceed #1? Probably, depends on what kind of mortgage and if prices fall (doesn't look good though)

5) How much will my salary be in five years? Currently at $36,400 and if I just get a steady cost of living raise every year I estimate around $52,000 in 5 years

6) Will my salary be able to hande the mortgage in five years? Without details of interest only loans you are looking at, I can only assume the mortgage payments will approximately double. A $1500/month payment will be nearly $3000/month. I haven't been looking at too many specific ones, just in general. A decent starter home would be around $180-200,000 roughly

7) Honestly, how long would you live in the house? Typically, people live in their first house for about five years. I would say 5 years is fair... maybe longer depending on how nice of a first home I could get and if it had room to grow, neighborhood, etc

 

[Slew Foot]

Originally posted by: dullard

There is just too much leeway in the process, too much opinion, and too much corruption.

Which works on the upswing as well as the down. Many central valley lenders are under investigation for forcing appraisers to come in at certain prices to artifically inflate home values.

My theory is that rents are rising as ARM resets kick in and people find out that they cant afford their second home anymore and try to cover themselves with increased rents. Im not exactly sure how long this can last, as a new flood of rentals hit the market, the negative cash flow will put more rentals onto the sellers market, increasing inventory further.

 

[dullard]

Originally posted by: cpals
I just paid all my credit cards off right now. The last three or so months I've been putting at least $1300 or more on the credit cards. Now all of that money can be put in the savings to start going for a house.

$1300/month is a good start. It should get you up to a ~$150,000 house if you stretch your budget. But does this mean you can't afford spending money if you use all $1300/month? If so, you'd probably want to go cheaper than that.

Don't understand... I don't have a mortgage right now

I meant, if you got the mortgage now, what would it cost a month?

That's another reason I shy towards renting a little more

It seems to me like your mortgage would be right near the $1300/month that you have available. That means you don't have much for these costs. Utility bills will be higher in a house, water heaters break down, etc. It sounds like you are almost there, but you need a little more money to be safe.

I haven't been looking at too many specific ones, just in general. A decent starter home would be around $180-200,000 roughly

I just don't think you can swing it yet. I'd suggest probably sitting back, putting that $1,300/month away. And in two years you'll have a 20% downpayment to make a mortgage well within your reach.

I would say 5 years is fair... maybe longer depending on how nice of a first home I could get and if it had room to grow, neighborhood, etc.

Well then you are ok to look at 5-7 year ARMs or interest only loans that are fixed payments for 5-7 years. That may not be the best option, but it is something to think about.

I'd mostly say wait a bit. You are almost there. Save money. Then get the house you really want without fancy loans.

 

[bctbct]

Bad idea, live within your means and if that isnt feasible, live below your means until you can afford to live within your means.

 

[JS80]

Rates are ready to top out right now. Fed suggested maybe on more rate hike. Does this mean you should buy a house with an ARM? NOOOOOOOOOOOOOOO. If you're planning to stay in the house short term, AND you have the down payment to lose equity on the house in the event of a "correction" then an ARM may be for you.