mugs
2-18-2005, 12:34 PM
I saw a commercial on TV last night for interest only loans. They gave an example of a $200,000 home that would cost ~$1200 a month with a 30 year fixed mortgage vs. $600-700 with their interest only loan. I just did some quick calculations, and it seems that the 30 year fixed mortgage at 5.75% would cost $1167 a month. The first month's interest is $958. Assuming the best case situation that they give you the same fixed rate on the interest only loan (I imagine if anything it would be higher), that's what you'd have to pay every month to maintain the principle at $200,000.
So how do they come up with the $600-700? The best I can figure is that your principle would go up every month. If your home does not increase in value at the same rate as the principle, you could be in for a serious raping when it comes time to sell.
(note: I'm not actually considering an interest only loan, just wondering)
Edit: It seems that interest-only loans do have lower rates because they are adjustable. But even when I use the current rates off bankrate.com, 30-year fixed comes in at $1094 a month and 3/1 interest only ARM is $723 a month. Not even close to the ~50% ratio they were advertising.
Edit2: This article (http://moneycentral.msn.com/content/Banking/Homefinancing/P73745.asp) lists vastly different rates for interest only vs 30 year fixed. That's closer to what the TV ad said. I would have thought the interest only rate would be higher, not lower, because there is more risk of default. This page (http://www.mtgprofessor.com/A%20-%20Interest%20Only/misperceptions_about_interest-only_loans.htm) agrees with me. (sub-edit: If I had continued reading, I would have seen that interest only loans DO have a lower rate than a fixed rate mortgage, but only if they are adjustable. They have higher rates than a comparable adjustable rate mortgage).
This is another interesting article (http://www.bankrate.com/brm/news/mtg/20020620b.asp), but I'm not sure if I agree with this:
Mortgage bankers McFadden and Larsen say interest-only mortgages benefit borrowers who invest the money they would have paid as equity. They come out ahead if their investment returns exceed the rate of home appreciation.
The rate of appreciation has nothing to do with how much equity you have in the house.
And this:
Tom Muldowney, a certified financial planner with Savant Capital Management in Rockford, Ill., says he has a 75-year-old client with a $45,000 mortgage. She could pay it off with a check if she wanted to. But she has a 4.75 percent interest-only loan, and the interest is tax-deductible -- and she's in the 38.6 percent bracket. With the tax deductibility, she's borrowing at an effective rate of less than 3 percent. It's a slam dunk to earn more than that with a well-diversified investment portfolio, so, McFadden asks, why pay off the loan?
Wouldn't the taxes on her investment earnings offset the tax savings from the loan interest? Or are investment earnings taxed at a different rate?
Edit 3ish: OK, from reading the second link I posted above, it seems that most likely the loan I saw on TV has a very short fixed period - even as low as 6 months. Then the rate goes up as well as your payments. Glad I got that figured out, thanks for all your help! :)
So how do they come up with the $600-700? The best I can figure is that your principle would go up every month. If your home does not increase in value at the same rate as the principle, you could be in for a serious raping when it comes time to sell.
(note: I'm not actually considering an interest only loan, just wondering)
Edit: It seems that interest-only loans do have lower rates because they are adjustable. But even when I use the current rates off bankrate.com, 30-year fixed comes in at $1094 a month and 3/1 interest only ARM is $723 a month. Not even close to the ~50% ratio they were advertising.
Edit2: This article (http://moneycentral.msn.com/content/Banking/Homefinancing/P73745.asp) lists vastly different rates for interest only vs 30 year fixed. That's closer to what the TV ad said. I would have thought the interest only rate would be higher, not lower, because there is more risk of default. This page (http://www.mtgprofessor.com/A%20-%20Interest%20Only/misperceptions_about_interest-only_loans.htm) agrees with me. (sub-edit: If I had continued reading, I would have seen that interest only loans DO have a lower rate than a fixed rate mortgage, but only if they are adjustable. They have higher rates than a comparable adjustable rate mortgage).
This is another interesting article (http://www.bankrate.com/brm/news/mtg/20020620b.asp), but I'm not sure if I agree with this:
Mortgage bankers McFadden and Larsen say interest-only mortgages benefit borrowers who invest the money they would have paid as equity. They come out ahead if their investment returns exceed the rate of home appreciation.
The rate of appreciation has nothing to do with how much equity you have in the house.
And this:
Tom Muldowney, a certified financial planner with Savant Capital Management in Rockford, Ill., says he has a 75-year-old client with a $45,000 mortgage. She could pay it off with a check if she wanted to. But she has a 4.75 percent interest-only loan, and the interest is tax-deductible -- and she's in the 38.6 percent bracket. With the tax deductibility, she's borrowing at an effective rate of less than 3 percent. It's a slam dunk to earn more than that with a well-diversified investment portfolio, so, McFadden asks, why pay off the loan?
Wouldn't the taxes on her investment earnings offset the tax savings from the loan interest? Or are investment earnings taxed at a different rate?
Edit 3ish: OK, from reading the second link I posted above, it seems that most likely the loan I saw on TV has a very short fixed period - even as low as 6 months. Then the rate goes up as well as your payments. Glad I got that figured out, thanks for all your help! :)