A few years ago, a friend of mine quit his job at a bank to focus on his own company. That can be a risky life change by itself, but in addition to his change in income, he and his wife were expanding their family. While I’m sure they would have been fine remaining in their apartment for a few additional years to ensure the new business could provide income, they wanted to purchase a house right away.
The mortgage broker they were talking to must have been very good. When they signed the paperwork for the adjustable rate mortgage, they were paying less per month (not including insurance and taxes) than the cost of rent in their old apartment. The premise could be valid. An adjustable rate mortgage allows you to qualify for a lower rate now while you’re earning less. Despite many studies that have recently declared that real income has been steady or has decreased for most workers over the past decade after taking inflation into account, most people have an impression that they can handle the increase in mortgage cost later because they’ll be earning more money.
For this particular friend, the decision to go with an adjustable rate mortgage paid off. His business found success early and he did not have a problem when the interest rate recently jumped. The situation could have easily gone the other way; in fact, it almost did. He managed to sign a major client at the right time, and it moved his business into profitability. Without the one client, his finances would have been in trouble.
Another friend of mine, when buying his second house, considered an interest-only mortgage. This is another good option to increase cash flow in the short term, but it means larger expenses later on. Unlike adjustable rate mortgages, if you’re paying only interest, you’re not building any equity in your home. In the beginning of mortgage repayment, building equity would be slow, anyway, but it’s helpful to start paying down the principal as soon as possible.
In the days of the runaway real estate market, homeowners could increase their equity just by watching the value of their home increase, but there are few locations where that strategy would work.
Along these same lines, homeowners would often take advantage of double-digit increases in value by refinancing their mortgage and walking away with cash. Enterprising individuals often find this cash helpful for making improvements to their home — and these improvements only pay off in terms of enjoyment of the living space, not future resale value — or investing in their own business.
Adjustable-rate mortgages, interest-only mortgages, and cash-out refinancing aren’t always mistakes. These could be the right options for many people, and several years down the road, one could look back and determine each one was, for any particular person, the best choice. These techniques often probe to be financially devastating if the housing market crashes, your income doesn’t increase as expected, or your business fails.
When plans don’t work out and the mortgage becomes too tough to handle, a family could find itself facing foreclosure.
Published or updated June 13, 2011.
{ 16 comments… read them below or add one }
Good post. I think your last sentence sums up what has happened to this country’s housing market over the last two and a half years.
If someone is not adverse to high risk financial decisions, then these options would seem fine. Personally I think these options could devestate a family if life handed out any curve balls.
Your first friend had a lot of determination to launch a business while quitting his job. Gutsy move. Glad it paid off.
It almost went the other way.
too me there’s a lot of risk taking an ARM or interest only mortgage. I’ll stick with the Fixed 30 year interest loan, better to be safe than sorry.
I guess I am too financially conservative. I think interest only loans are horrible ideas. My thought is you always pay more when you are young, healthy and have options. And if you don’t have enough for a standard mortgage loan, you aren’t ready to buy a house.
I agree with this. Moderation in all things, including earning free money. Things can go south very quickly.
Interest-only loans can be useful as a great way to avoid disaster when you do get one of those curveballs. I used the interest-only option for home remodelling. Although I never paid just the interest payment it was there as an option and my payments varied as my ability to pay varied. No curveballs meant no interest-only payments so I guess some luck is involved.
It might take a good level of discipline to do what you’ve done. For someone who can almost always pay extra to their mortgage, an interest-only mortgage could provide a cushion of extra cash flow for the occasional months a major payment isn’t possible.
I agree with Ceecee above. If you can’t afford a standard mortgage then I don’t think you should be buying a house. Of course they can work out well, but that doesn’t mean it’s a smart decision. It only appears smart because it happened to work out.
I agree with Lynn: Even one curveball could have knocked them down like milk bottles at a carnival. For example, any childbirth complications or fetal medical emergency might well have ruined them financially.
I’m glad it worked out all right. Then again, sometimes you read about somebody falling from a second- or third-floor building and surviving with only bruises. That doesn’t mean you should feel free to jump from that height because, after all, other people have done it without injury.
LOL Good comparison!
Making three major life changes at once was a big risk, no doubt. I am glad that it worked out for them but I would never have the courage to do so. Either way, it is good to know that some people are still having success out there achieving their dreams.
I would be interested in your thoughts -at the time -Flexo. Did you agree with his moves, or were you scared for your friend?
First off, your friend must have nerves of steel since I could not do what they did. Second, I had a friend who got an interest only loan despite the advice of everyone in our office. Everything was good for a year and a half and then she was laid off from her job working in our office. Her husband had his hours cut about the same time and guess what. They lost the house about 9 months later. I felt so sorry for her when she told me but a part of me wanted to say “We told you not too”.
as others have said, wow! i do not think i could make the move your friend did. i am glad it worked out, but, without knowing all the details, it would seem he was very fortunate. not so much in that he did not have a great idea…etc…but one “surprise” and it could have been a different story.
on another note, i would love to back in time and see how many people in 2006/2007/2008 had even heard of arms, interets-only mortgages and cash-out financing