dainthomas
Lifer
- Dec 7, 2004
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dullard
Elite Member
- May 21, 2001
- 25,913
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No that isn't a typo. And your experience is wrong. Are you comparing apples to oranges? Are you comparing variable IO loans to fixed traditional loans? That is two changes (variable vs fixed) and (IO vs principal). If you compare apples to apples (both variable), then paying principal is almost always the lower interest rate. And thus my example is almost always is applicable.
Is there a calculator that shows whether paying more to the principal vs investing that difference would be better? Say mortgage payment is 3k, is it better to pay 3.5k or invest that $500 into a fund.
dullard
Elite Member
- May 21, 2001
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I bet there is something out there that does that. I don't know though how to find one. It took me only 3 minutes to do that math (it took longer to type it). Thus, a calculator like that would be easy to program.
IO is great for people like MWilding who have variable incomes. IO is great if you have a really booming market and are a flipper. Other than that, IO is usually not the best option. That is despite the large number of books and gurus touting their ideas on infomercials to make money with IO loans.
GasX
Lifer
- Feb 8, 2001
- 29,033
- 6
- 81
Which is greater the interest rate of your loan or the predicted return on your investment? It's a very simple calculation.
However, you other factors should also help drive that decision.
How much are you already investing?
How risky is your portfolio (i.e. would a small 5% risk free investment be good for your portfolio)?
Do you have the savings to absorb a loss in value if your circumstances change and you have to move?
Do you have other higher interest rate loans that need paying off?
Are you a disciplined saver?
etc...
Yes, I understand how paying off something you're paying interest on is better than making less interest. Hence my advice to put that difference towards your 19% credit card (which would net a positive benefit in your example).
Like I said in a later post, I don't believe the bank would offer a lower interest rate for interest+principle. It's in their best interest (no pun intended) for you to pay interest only, so usually, the interest only loan has the better interest rate. Yes, if you can get the better interest rate by paying principle, my all means, do it.
Assuming both have the same interest rate, it would look like this:
Interest only at 5.625% payment: $1406.25
With principle payment: $1726.97
Difference: $320.72
If I did my math right (did it real quick in Excel), on an 8% investment, the difference would have made $13,087. More than the $12,545 in equity. And paying off high interest credit card debt would net even a greater amount. (Which is what I personally would do, as I have debt I'm paying more than 17% on.)
Again, my argument assumes interest-only is the same or better interest rate. (Which it should in most cases.) I realize you were referring to the rates in the OP, to which I agree, take the lower interest loan.
dullard
Elite Member
- May 21, 2001
- 25,913
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No, in most cases, interest only should be HIGHER rates. Why? It is more risky for the banks and investors. They have far more foreclosures with IO loans. They also need their principal back so they can make more loans (earning more closing costs). For both reasons, IO loans are less profitable for a banks unless they raise the IO interest rates. Thus, IO interest rates are usually higher as they should be.
There are a lot of teaser IO loans, shock-payment IO loans (where your payment goes up dramatically when you least afford it), and massive payoff penalty IO loans (if you pay the mortgage off you must pay a massive penalty). With these tricks, IO loans can appear to be cheaper on the surface. But if you take in the whole picture, IO loans are usually more expensive.
Well, I must have had a dumb bank, because I took the interest-only, as the interest rate was 1% lower than the interest+principle I was offered. I assumed they want you to pay as much interest as possible, so that they can continue to charge you interest on the total amount, for the life of the loan. Why would they want their profit (interest) to decrease? Maybe the recent influx of foreclosures since the market dive has changed their philosophy.
Vic
Elite Member
- Jun 12, 2001
- 50,422
- 14,337
- 136
Sigh... typical cost for IO to a conforming loan is about a 1 point hit to fee, which translates to 1/4-point of rate.
Otherwise, your post is nonsense, sorry to say. An IO loan can involve any and just as many "tricks" as a fully amortized. They can be fixed, adjustable, have a prepay, not have a prepay, whatever. None of that is dependent on whether the loan is IO or fully amortized. You haven't found the single solution to determining a "good" mortgage or a "bad" mortgage.
Vic
Elite Member
- Jun 12, 2001
- 50,422
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Of course. And there are pros and cons to renting as well. That's for the OP to decide based on his own individual financial needs, not for some internet doomsayer with no knowledge whatsoever of the OP's finances to make sweeping generalizations about.
Housing, adjusted for inflation, appreciated at a national level of about .5% for 110 years, meaning about 5% with inflation. Do you seriously think that's going to last much longer?
Vic
Elite Member
- Jun 12, 2001
- 50,422
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Well, the fact is that IO costs a touch more, but (all else being equal) with that cost comes added flexibility if the OP is educated and disciplined enough to take advantage of it, and that assuming that he needs or wants that flexibility, or if that flexibility can even provide him with any benefit or advantage (which it might not).
The primary benefit of IO loans is that they provide a lower minimum payment while re-amortizing each and every single time the borrower makes a principal payment (because the payment is always principal * rate / 12). That benefit lasts for the entire IO term, which is usually the first 10 years of the loan (but may be shorter, read the terms!). The primary benefit is also its primary negative, however, which is that (all else being equal to a fully amortized fixed) once the IO period is over, the loan re-amortizes a final time based on remaining principal balance and length of term to maturity (meaning that if you started with a 30 year loan with 10 year IO period, and never made more than just interest payments, after the IO period is over then the payment will go up to what it would have been initially on a 20 year fully amortized). As the OP doesn't intend to keep the loan that long however, that should not be a factor in his decision.
That's it. That's the OP answer. The rest of this thread is BS and nonsense.
The primary benefit of IO loans is that they provide a lower minimum payment while re-amortizing each and every single time the borrower makes a principal payment (because the payment is always principal * rate / 12). That benefit lasts for the entire IO term, which is usually the first 10 years of the loan (but may be shorter, read the terms!). The primary benefit is also its primary negative, however, which is that (all else being equal to a fully amortized fixed) once the IO period is over, the loan re-amortizes a final time based on remaining principal balance and length of term to maturity (meaning that if you started with a 30 year loan with 10 year IO period, and never made more than just interest payments, after the IO period is over then the payment will go up to what it would have been initially on a 20 year fully amortized). As the OP doesn't intend to keep the loan that long however, that should not be a factor in his decision.
That's it. That's the OP answer. The rest of this thread is BS and nonsense.
What's funny is that I see the meltdown from the top, but in reality I have nothing to lose from it. As far as being an internet doomsdayer, I have never been that, I only look practically at the problem.
As opposed to somebody suckling from that source currently who really thinks that this market is sustainable and a regression to the mean is not inevitable.
People like you are equiv to Blodget or other .bomb tools. People like me were reviled and called old fashioned or doomsdayers in 2000.
This market has a while to go before it hits bottom. You can buy in at just below the top or you can wait a little bit and see where the ride goes.
If this is the bottom, what do you have to lose? A couple grand in appreciation?
If it's not, what do you have to lose? Nothing except for some rent. As long as what you pay in rent is less than what the house depreciates plus interest, you win.
I could have moved out to the burbs around NYC and bought a massive place for what I am paying in rent (double from VA) at a doorman highrise. Why didn't I? Because despite NYC's massive job market and limited downside, I think that prices will still go down.
If I am wrong so what? If I am right, I will gain. Either way, a 3-year investment horizon won't get him anything.
dullard
Elite Member
- May 21, 2001
- 25,913
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Hmm, this whole thread is about a 0.25% rate difference. Why is that a sigh? I did my whole analysis based on that 0.25% difference. I never said IO was MUCH higher, just that they usually are higher for otherwise compariable loans.
Plus you brush 0.25% away as if it were nothing. 0.25% is massive when talking about an expensive home.
Where did I say an IO loan can't be fixed, can't be adjustable, can't have a prepay, etc? I just said the ultra low 1% less IO loans that Rob9874 discusses have hidden tricks or are not compariable loans. Can you otherwise explain why two identical loans would have 1% less interest for the IO version?
I didn't know I was supposed to find a solution. Heck, that was another thread. But how about some of these:
1) Disclose what the full cost would be in very simple text that even a moron could understand once the variable rate hits. Don't bury it as being 6% + the 1-year LIBOR rate as defined by the WSJ using the average of the last four months that end with the letter R and which might contain three or more thunderstorms over the lattitude of a region that is similar to the lattitude of the city Bombay. Yes I'm exaggerating. Put the mortgage terms as they need to be defined. But ALSO put the mortgage terms as if the interest varied today. So if the comparison rate is 8% today, put that it will be 6%+8% = 14% interest rate in big bold numbers right next to the 3% teaser interest rate.
Yes, in 6 months when the variable rate changes, that comparison index might not be exactly 8% anymore. But at least they have a clue that their interest rate will be near 14% for most of the term of the mortgage.
2) Include right next to the teaser rate and my proposed variable rate if the variation was today two other rates. Include the lowest possible rate and the highest possible rate. I want to see this:
Starting rate: 3%.
Variable rate if variation started today: 14%.
Lowest variable rate: 10%.
Highest variable rate: 18%.
I want to see that right at the top center of a form that they first sign. Only then will the stupid borrowers have a chance of knowing that this deal is probably better:
Starting rate: 5%.
Variable rate if variation started today: 8%.
Lowest variable rate: 3%.
Highest variable rate: 12%.
Right now, the customer sees the 3% in my first example and is confused by everything else (hidden in text burried on page 38 of the mortgage forms). But maybe, just maybe if they saw all four possible rates, they'd see the 5% now is probably much better.
Heck, even better. Put the monthly payments right next to each of those lines. They'll soon see that their affordable seeming $1000/month mortage becomes an $1800/month foreclosure.
3) If the mortgage broker suggests refinancing to avoid those problems in #1 and #2, force the broker to include the typical refinancing costs in the overall cost disclosure. Right now, they just say "you can avoid that payment shock by refinancing". The stupid customer doesn't realize that the refinancing will cost thousands of dollars that they don't have right at the time they also need to pay 50% or more higher mortgage prices.
4) End prepayment penalties that are often brushed aside when a broker says you can just refinance to avoid the problems in #1 and #2.
5) Developing a faster form of credit score reporting so that people can't take out multiple mortgages in a short time without disclosing them.
6) Require more income verification steps for people without a set income (ie work on the liar loan problem).
7) If a mortgage still goes through where the buyers are foreclosed, let the buyer suffer. But if a mortgage broker has a long history of much greater than average foreclosures for that market segment, then that broker is probably predatory. Have a system in place to determine if this broker is truely predatory and the proper proceedure to end that predatory practice.
8) Disclose up front what the interest COULD have been if the customer had a modest increase in their credit score. Then tell them how to get that credit score increase before signing on to a mortgage.
A bad mortgage to me is a mortgage that the customer didn't understand and certainly can't pay off in most realistic scenarios. Yes, the customer is at fault for signing something that he/she didn't understand. But it is still a bad mortgage because the customer shouldn't have gotten a mortgage that any outsider could see isn't affordable. That mortgage should NEVER have been available to that customer. I guess I want to hold the brokers to a higher ethical/moral standard than you do.
Yes, these changes will exclude some people from the housing market. Yes, they will raise costs for the sub-prime borrowers. But, heck, these people can't afford it anyways, they shouldn't be given those opportunities. Let them come back when they can afford it.
couple of things to add to this.....
1. a house will earn equity no matter what is owed
a 250K house that appreciates 10 percent will earn 25K whether it is paid off or there is a 250k mortgage on it.
2. mortgage interest is tax deductible so a 5.25% loan will not cost 5.25 to borrow if you earn any kind of taxable income.
putting the money into investments could potentially earn you a better return than the cost of mortgage. Roth is tax free to boot
5.25% - tax savings rate = borrow cost (will be less than 5.25%)
you can beat that will some cds right now.
3. the only reason to ever pay off a house is if you are going to die in it or retire in it or on the money that it generates if you rent it.
most houses have been treated like big piggy banks. you can earn more in investments than most houses over the long run (err...i think) the last couple of years in real estate are unsustainable and will not happen in my lifetime again.
Now in saying this do i think interest only is for everyone? NO of course not.
But there are situations that they make sense.
I have an interest only mortgage on my house 7 year ARM.
Plenty of time to stay my 2 years, earn my tax free equity and stave off any kind of market correction 2-5 years
I choose this mortgage because I had 3 things going for me.
1. I built my house and had an absurd amount of equity in the place. Don't have to worry about short term 10-20% market corrections.
2. If i need to convert to a fixed interest mortgage i can afford the payment
3. I have the will and desire not to blow the money and invest the difference in my payment amounts in no/low tax investment vehicles.
I also take full advantage of the tax savings as I have high taxed incomes.
(don't own my own business).
my 2 cents
-fish
1. a house will earn equity no matter what is owed
a 250K house that appreciates 10 percent will earn 25K whether it is paid off or there is a 250k mortgage on it.
2. mortgage interest is tax deductible so a 5.25% loan will not cost 5.25 to borrow if you earn any kind of taxable income.
putting the money into investments could potentially earn you a better return than the cost of mortgage. Roth is tax free to boot
5.25% - tax savings rate = borrow cost (will be less than 5.25%)
you can beat that will some cds right now.
3. the only reason to ever pay off a house is if you are going to die in it or retire in it or on the money that it generates if you rent it.
most houses have been treated like big piggy banks. you can earn more in investments than most houses over the long run (err...i think) the last couple of years in real estate are unsustainable and will not happen in my lifetime again.
Now in saying this do i think interest only is for everyone? NO of course not.
But there are situations that they make sense.
I have an interest only mortgage on my house 7 year ARM.
Plenty of time to stay my 2 years, earn my tax free equity and stave off any kind of market correction 2-5 years
I choose this mortgage because I had 3 things going for me.
1. I built my house and had an absurd amount of equity in the place. Don't have to worry about short term 10-20% market corrections.
2. If i need to convert to a fixed interest mortgage i can afford the payment
3. I have the will and desire not to blow the money and invest the difference in my payment amounts in no/low tax investment vehicles.
I also take full advantage of the tax savings as I have high taxed incomes.
(don't own my own business).
my 2 cents
-fish
Roth IRA is not tax free. You pay the tax before you invest and can't deduct it on your tax returns.
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