Home Buying
Are interested-only loans principally risky
By Kathy Bushouse and Robyn A. Friedman
Sunday, June 19, 2005
A product in demand
Between 15 percent and 20 percent of the mortgages issued by Fidelity Federal Bank & Trust are for interest-only products, said Ken Stone, senior vice president for retail residential lending. If you want to be competitive in the marketplace, he said, you have to be able to offer these loans.
The double-digit yearly gains in South Florida's median home prices play a big role in the new types of mortgages, said Les Grene, senior vice president for retail residential lending at Coral Gables-based BankUnited.
"Look at the price of homes now," Grene said. "It's almost dictating you find a way to find an avenue to get into something that's affordable."
About 95 percent of the business that Anthony Cutaia conducts at Cutaia Mortgage Group Inc. consists of mortgages with "interest-only components," he said. CEO Cutaia touts the benefits of these loans at seminars and on radio and television programs that he pays for and hosts."There is no advantage ever in making a principal payment on a mortgage," Cutaia said. He said a homeowner will make more money taking the amount that would have been used to pay down the loan principal and investing it.
In fact, he suggests that his clients set up a "mortgage savings account," an interest-bearing account where they deposit the difference between what their conventional payment would have been and their interest-only payment. By the end of five years, he says they will have come out better financially than if they had made principal payments.
But some regulators and analysts are concerned that homeowners won't be ready in five or so years when their interest-only bill balloons in size to include paying down the loan principal. If the monthly amount increases too much, homeowners won't be able to pay it and their house could wind up in foreclosure.
"They are financing lifestyles that they can't afford," said Howard Dvorkin, founder of the Sunrise-based Consolidated Credit Counseling Services.
Worsening the problem is the possibility that South Florida suffers from a real estate bubble -- a market with over-inflated values. Homeowners with interest-only loans don't build "equity," or ownership, in their homes if they're paying only the interest. If the real estate market slows and prices slip, that could be a problem.
"They're going to have nothing," Dvorkin said.
Hope and confusion
Some homeowners take out interest-only mortgages because they think the housing market will keep rising and they want to make sure they're getting in before homes become even less affordable, said Nicolas Retsinas, director of Harvard University's Joint Center for Housing Studies.
It appears "they're just desperate," Retsinas said. "My guess is people are perhaps thinking, `I'm sure in a year my salary will go up. I'm sure in a year this will appreciate so much that if I can't make the payments I'll be able to sell it.'"
People also may be thinking only about their monthly mortgage payment, and paying little heed to the other costs associated with homeownership, such as insurance or property taxes or maintenance, he said.
Another problem with these loans: Borrowers may not understand what they're getting into, said Keith Gumbinger, vice president of HSH Associates, a financial publisher in Pompton Plains, N.J.
Gumbinger said he has corresponded by e-mail with people who took out interest-only loans and "did not truly understand the product."
"We are increasingly selling mortgages on the ability of the borrower to make the monthly payment, at least today," he said.
For their part, lenders say interest-only loans aren't for everyone. But they think that today's borrowers are savvier and more knowledgeable about the risk they're assuming, thanks to the Internet and other available research that lets people compare rates and products before buying.
"Your consumer today is so much more educated than he's ever been," said Fidelity Federal's Stone. "All of that has combined to creating all these programs."
Now banks had better hope that homeowners are smart enough to keep the roof over their head if home prices fall through the floor
