Many of the people I’ve grown up with have been buying their first homes at this point. One of my closest friends (and his wife and daughter) is selling his first home and moving onto bigger and better. So yes, I’ve been thinking about it a bit. In that respect, this article caught my attention this morning.
For first-time home buyers, it is incredibly easy to borrow more than the value of a home and make the purchase. The article describes three potentially dangerous methods that have been popular.
- Piggyback Loans. You used to need 20% of the home’s value at the time of purchase. That’s not common anymore. 42% of all first-time home buyers do not put any money down. Without the 20% you have to pay private mortgage insurance or borrow their down payment from a home equity loan. This will only pay off if you can afford to pay more than the minimum each month, and there are many pitfalls of a variable-rate home equity loan.
- Interest-Only Loans. The buyer pays only interest for the first five, 10 or 15 years. If the buyer doesn’t budget for higher payments down the road, he or she could run into trouble. This might be good for someone whose income is definitely going to go up, but that can’t always be a sure thing.
- Minimum Payment Option. Each month, the home owner has several choices. They can either pay the principal and interest as they would on a regular mortgage, they can pay only the interest due, or they can make a smaller “minimum payment” and any outstanding interest gets added to the principle. Borrowers who use the last option often will see the balance of their loan go up over time.
There are some situations where one of the above options might be a good choice, but it’s best to understand the drawbacks.
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Yes, in fact, we went with an interest-only loan for our new house, and there were several reasons. The first one was that we knew that cash would be tight when we first moved in because of all the other expenses associated with this purchase. Second, with my non-standard income, we never know from month to month if we’ll have a lot of money or not much at all, so that way on months when I do very well, we can pay more than just the interest and on the other months, we can pay interest only. Then, hopefully, in a year or two, finances will have stabled out from the initial move expenses and we’ll be able to move to a more standard loan.
As you say, there are lots of options. The important thing is to go into it with a clear head and not make an emotional decision based on simply wanting to buy.
It seems like that option makes sense for you. Good luck!
Darren, it sounds like you’ve found a pretty good way to deal with irregular income. A lot of people just don’t seem to understand it, though, and that unfortunately includes more than a few loan brokers.
There’s an article titled The Principal Facts of Interest-only Mortgages, which explains the pros & cons pretty clearly. It was written by the Keith Gumbinger quoted in the CNN article. It’s been very well received. (Full disclosure: He’s in the office next door to mine. ;)
Paul,
I liked that article you posted and I like how it gave pros AND cons. I’m looking into getting a home and I’ll no doubt reference that article if I look into interest only mortgages in the future.
Jim, glad you liked it. Our site offers a lot of free advice about personal finance. Hmmm, maybe we should start a blog… ;}
Interest only loans are really good for those with “wavy” cash flows. Interest only loans aren’t inherently bad, it’s when they are abused by people to buy houses they can’t afford that they can lead to trouble.
Also, I bought my house with only 5% down (and I had to borrow that!) about 2.5 years ago. I’ve since taken out a home equity line to get rid of PMI, and I have my first mortgage down to 22 years left, and my second has about 9.5 left. Not ideal, but I’m making it work.
Great post! Interest only mortgages are so controversial these days. Along with religion and politics, you can’t bring up the topic of home loans at dinner anymore!
These kinds of loans can definitely work for some people, the trouble is when borrwowers use interest only loans to buy a house that they couldn’t afford with a standard loan.
There’s an interesting article about this topic by John Ulzheimer online here – http://www.creditbloggers.com/2005/11/interest_only_m.html
I sound like I’m in the minority here, but an interest only loan scares me a lot. I couldn’t imagine paying money and not watching my balance go down. I think I’ll just pay off my debt and save up my down payment.