DEAN CASO
‘A significant savings’
After gaining popularity in California in recent years, interest-only loans are riding the jet stream east and the mortgage product is beginning to take off in Massachusetts.
Some analysts say the push for the interest-only loan is due to rising house prices in the area and the demand for bigger homes.
Belmont Savings Bank has taken seven applications in the last month for its newly introduced interest-only loan program and approved its first one on May 21.
Boston-based Sherwood Mortgage has been offering an interest-only loan in the form of a 30-year fixed rate with payment on interest only for the first 10 years. John O’Hara, managing partner at Sherwood Mortgage, said the product has become more popular in the last nine months.
Belmont Savings offers an interest-only loan that allows a borrower to pay just interest on their outstanding balance for the first five years of the loan. After that, the payment readjusts to include principal and interest and the loan is re-amortized for the remaining years.
Keith A. Andre, senior vice president and chief lending officer at Belmont Savings, said the bank has seen strong demand for this type of loan.
“Nationally, it is becoming more popular with high-net-worth players,” said Andre. “Our clientele seems to be that type of borrower. It’s a mortgage for the up-and-comer.”
Dean Caso, president of Needham-based Homevest Mortgage, which also offers an interest-only loan, agrees that type of mortgage is geared primarily toward the “high-end clientele” and for loans exceeding $500,000.
Caso said that for a fully amortized $500,000 loan at 6 percent interest, monthly payments are almost $3,000. With the interest-only loans during the interest-only stage, a monthly payment is $2,500.
“You pay only interest,” said Caso. “So it’s a significant savings each month.”
For a typical Belmont Savings borrower who might purchase a home in nearby Lexington for $800,000 (the median sales price of a single-family home in the town last year was $615,000, according to statistics compiled by The Warren Group, Banker & Tradesman’s parent company) and put down 20 percent using a five-year adjustable rate, they would pay $3,485 in principal and interest montly. With taxes and home insurance added into the mix, the monthly payment would be more than $4,000, requiring the borrower to have an income of approximately $152,000 a year.
With the interest-only loan, the same house with the same down payment for the first five years of interest-only payments would cost $2,467 in monthly payments. Add taxes and home insurance and the monthly payment would be slightly more than $3,000, requiring the borrower to have an annual income of $115,000.
‘Comfort and Options’
The loan is geared toward the borrower who will have a steady increase in income as time goes on, said Andre.
“People are hoping their income is higher [in the future],” said Robert B. Segal of J. William Mantz Investment Advisors.
Andre doesn’t recommend an interest-only loan for someone who will see only a 2 percent to 3 percent income increase each year, and Segal said the loan benefits someone looking to purchase a higher-priced home. He doesn’t view it as a mortgage geared toward starter homes, although there are exceptions.
O’Hara said it can be an ideal loan for someone who is graduating from medical or law school. While they can start off with a low payment, such young professionals have long-term income potential to pay down the principal.
Brian Koss, regional vice president of Countrywide Home Loans, said a typical first-time buyer who might benefit from an interest-only mortgage could be a doctor or lawyer who has not had an opportunity to purchase a home until the completion of school.
But Caso said a client that has the ability to pay down the principal during the interest-only period would benefit more from this type of loan. He said people who are self-employed or in sales are a good fit for an interest-only loan because they may receive bonuses or a larger, unexpected commission check, allowing them to pay down the principal if they so choose.
Andre said that without careful planning, monthly payments after the designated interest-only stage could be steep. He noted that if a borrower does not refinance in five years, the monthly payment could shoot up dramatically.
Caso said that on a $500,000 loan with monthly payments of $2,500, things change greatly when the five-year interest-only period is up. With principal and interest, monthly payments after five years on such a loan would increase to $3,221.
O’Hara said the interest-only loan can work well, especially if the borrower takes the additional money that would have been spent on principal in the initial years and redirects it into an investment.
But many borrowers don’t plan on owning the home for the full 30 years of a mortgage. Caso said some buyers take advantage of the lower payment and, after the five or 10 years are up, sell the home, sometimes reaping a windfall if the home’s value has appreciated.
But Koss cautioned that interest-only loans, like a credit card, can be dangerous if a consumer spends more than they can pay off.
If a homeowner isn’t paying down their mortgage and home values drop, there is a shortfall in equity and a higher chance of foreclosure, Segal said.
However, both Andre and Koss said that an interest-only mortgage can free up cash that could be spent on other debt, like college payments or home improvements.
“We’re in a HGTV [Home & Garden Television] world, everyone wants immediate gratification,” said Koss.
James Dougherty, president and chief executive officer of the Massachusetts Mortgage Association, said interest-only loans in today’s market are serving a role similar to one filled by adjustable-rate mortgages in the past. In the past, when fixed interest rates soared to 18 percent or above, consumers were able to get a mortgage for 12 percent with ARMs.
“Interest-only comes along because the cost of housing is so expensive,” said Dougherty. “People are searching for other ways to get into homes.”
Koss said that, 40 years ago, most people bought a home with the intention of paying off the mortgage. In today’s society, the mobility of many people creates less demand on paying down a mortgage.
“There is less talk of paying off the loan,” said Koss. “It’s just trying to get housing.”
Koss said lenders today are more focused on providing multiple options to consumers. With an interest-only loan, the consumer is able to decide when to pay principal (Belmont Savings notes a borrower can start paying the principal on their interest-only loan at any time during the first five years).
“It’s used for comfort and options,” said Koss.
O’Hara said the flexibility of the monthly payment can be enticing, especially for those who want to control their cash flow.
There are some who view the interest-only loan simply as another product that banks and mortgage lenders can offer.
“It’s a useful tool,” said Dougherty. “It is one more financing tool that makes sense. If offered appropriately it’s simply another product a bank has.”
Segal said that more banks are beginning to offer more innovative loans to meet customers’ needs.
Andre said he’s seen a mix between customers who are educated about the loan and others who need an explanation.
“Provided people understand and it matches life circumstances, there is no reason not to do it,” said Dougherty
But just about everyone agrees that it is a loan that will most likely stick around and gain in popularity, especially if home values continue to appreciate significantly.
