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June 21, 2005

Interest-Only Loans


Chang Mook Sohn, the state’s economist, was talking about the booming housing market, and the risk in it. He cited an interesting statistic: in the Seattle market (and probably that meant King and Snohomish counties), 37 percent of home buyers were applying for interest-only mortgages.

The highest proportion, he said, was in San Diego: 47 percent. But Seattle was eighth in the nation in its appetite for this type of loan.

In an interest-only mortgage, you pay interest for a fixed time—typically 5, 7 or 10 years—and at the end of that time, your loan converts to a traditional principal-and-interest loan. At that point you owe just as much money as at the beginning, because you haven’t paid down any of the principal.

If you catch things right during a housing boom, these loans can be tools to make money. Basically, you can buy more house. But you are also taking a greater risk in case of a downturn.

I did a web search for “interest only loans” and read some of the appeals. Some warn of the risks. One says: “These interest only mortgage home loans are the best for people who are self-disciplined and who understand the potential risks associated with these loans.”

But are the people attracted to these loans self-disciplined?

Another says: “Your mortgage loan is the lowest-cost source of credit available to you. Yet each month you are forced to pay down your loan.” (The injustice of it!) What if instead you could use the money…for other purposes, such as investing or paying off high-cost debt?”

Yes, or on a foreign trip, or a boat, or some new toys.

This is dangerous stuff. Several web pages note that interest-only loans were used in the 1920s. Yes, and some of the people who took out those loans regretted it in the 1930s. Others did O.K.

Caveat emptor.

Respond to Bruce.

 
Posted by Bruce Ramsey at June 21, 2005 06:31 PM



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