Myth: Interest only loans are a great way to stretch your dollar each month. You get to build up equity without a huge house payment.
Fact: Interest only loans are a great way to take away all the benefits of having a mortgage while still keeping all the bad parts. And the length of the loan becomes a ticking time bomb of looming disaster.
I don't have to tell you all the supposed benefits of an interest only loan. The banks and mortgage lenders are doing their darndest to make sure you understand why interest only loans are the greatest thing since cavemen first started seeking shelter in caves.
But again--use your head. If your banker is really, really pushing it on you in advertisements, in print ads, and in face-to-face visits, who do you think it really benefits?
I had a friend who knew a guy who owned a used car lot. One of those lots you see in the not-so-nice parts of town that catered to people with bad credit. Here's the way his operation worked:
He'd get a car cheap. Either at an auto auction or through some other means. Say he'd pay $750. Then he'd put a $3000 sticker on it. When Joe Public came in to buy it, he'd tell the guy he could finance the $3000, but he'd ask for $750 down. He'd have made back all his costs the moment the guy made the down payment--the rest would be pure profit. Pure profit with over 20% interest. If the guy faulted on payments, he'd go repo the car and sell it to somebody else. This time, even the down would be profit.
Interest only mortgages are a way for the bank to do the same thing. They buy your house up front, and the house remains an asset--their asset, not yours--through the whole process. They get to collect money from you every month, just like you were renting, except that unlike renting, you pay the property taxes and you have to fix anything that goes wrong. Since the payment is interest only, you lose the only benefit of a regular mortgage--in a regular mortgage, some of your monthly payment is working towards making the house yours, free and clear.
Now the kool-aid drinkers of interest only out there are still asking "What about the increasing property values? Won't I get the increased value of my home as equity to help me buy my next home?"
In theory, yes. But the problem is that when you get the loan, you start a timer ticking. A time when your payment is going to "balloon" from something you can afford to something you can't afford. And when you're under time pressure, you become the target of bargain-hunters: a "Must-Seller."
Real Estate gurus like Robert Allen go on and on about how wonderful "Must-Sellers" are to people looking for bargains. These are people who have a house they need to sell and need to sell now. This could be because of a recent divorce, because of a pending foreclosure, because of a recent job loss, or--you guessed it--because of a pending balloon payment. When you're selling under time pressure, you're usually forced to settle at a lesser price than you would have if you'd have had more time.
And, chances are that if they got you to drink the interest-only Kool-aid, they'll get you to drink the second-mortgage-for-any-equity Kool-aid, and you'll squander that away, too.
The banks, knowing people have caught on to the five-year deadline, and fear it, have agreed to do fifteen year interest only loans, but "only if you have really, really good credit." It's hard to get anybody to muster up much fear of a looming deadline fifteen years away. What a bargain!
Except that $1000 dollars or whatever you think you were saving each month will end up costing you the full value of your home. If you'd have done what every financial person who doesn't sell loans recommends and got a 15 year regular mortgage, come 15 years and one day, you would own your home free and clear. No more payments. Now you're free to use that entire payment each month to do whatever you want. Save, take trips, whatever. In the meantime, your kool-aid drinking buddy is having to start all over, either by moving or by refinancing.
Remember--your goal isn't just to get a house. It's to get a house paid off.