Mortgage Products: The Interest Only Loan

Many of today's consumers are financing their homes withinterest only loans. Not very many ofthose consumers are aware that some of the grandparents, or great-grandparentsalso financed their homes with an interest only loan. I myself wasn't aware that this type of loanexisted prior to the mortgage market of today. But, we weren't the first to use the interest only concept. During the Roaring 20s, many ofmiddle-America's citizens chose to finance their homes with interest onlyloans.

Why did they not remain popular, and does this tell us anything about the market oftoday? Well, let's take a moment toexamine the interest only loan of the 20s compared to the loan of today, andmaybe we can become better educated shoppers.

The interest only loan of the 20s was a pure product. This means that the mortgages were interestonly for the life of the loan. At theend of the mortgage period, nothing had been paid against the principal. Only the interest payments against theprincipal borrowed had been paid. Thisworked really well until the crash of the stock market and the Depression. At this point, many of the families that hadlived in homes paying only the interest due were forced from their homes whenthere was no money and no jobs. Manylending institutions were left with foreclosed mortgages, and no cash. The traditional lending institutions at thispoint, simply shelved the interest only loan, in favor of more equitablelending; in other words, they preferred to loan money for a mortgage that wouldbuild equity. This gave the homeownersomething comparable to savings, and the banker a lower outstanding mortgagebalance.

That is a lesson we should carry forth when lending today, and using the interest onlyoption. Most of the products offeredtoday do carry a limit for the term of the interest only element. Generally, if the loan is a 30 year loan, nomore than half can be used towards the interest only option. At least someone has exercised some level ofjudgment in providing for a cap, or limit to the interest only term.

In today's society, everything we see encourages instant gratification, and home mortgagesare no different. Instead of sending amessage that says, if you want more house, you need more money, we send themessage that it's ok to borrow beyond your means. Now, in all fairness, there are some mortgageshoppers that fit the description of the candidate for the interest only loan. Investors, and candidates who do not intendto keep a home for longer than 5 years, do benefit from the interest only loanoption. But for the typical homeowner,the interest only mortgage only prolongs the equity building process, and mayoften put the borrower in a situation where he or she cannot actually affordthe payment when the principal and interest period begin.

Thanks to the booming real estate market, the interest only loan option, and theexpansion of the mortgage product market, the increase in purchasing power hasenabled many prospective homeowners to actually make a dream a reality. But at some point, the market will cease toboom, and the mortgage market will cease to expand. Will the consumer that purchased the interestonly loan be able to afford the consequences, should the home suddenly not beworth the original loan amount? Let'shope for the sake of the unwary homeowner, this is a situation we do not soonencounter. And, for the most part, Idon't believe we'll see this any time soon. Thanks to the natural disasters along the gulf coast, and the continueddemand for real estate and building materials, the housing prices we'recurrently experiencing, along with the growth we've seen for the past couple ofyears, should continue at the same rate. 

There are other, more stable loan products available, but these products don'tprovide the kind of return for the mortgage lender that the interest only loansdo. They also don't pose the risk theinterest only loans pose. The interestrates, however, are very competitive on these loans, and I don't' look for thegeneral public to decide in favor of safety over savings. After all, nothing ventured, nothing gained.