Homequitybuilder

We’ve all seen the catchy advertising- on TV, in the newspaper, online, etc. 

“$525,000 mortgage for only $1700/ month!”

“Do you think you’re paying too much for your mortgage?  Call us today!”

The obvious answer to this second question is- “Of course I’d like to pay less for my mortgage payment”.  But at what cost?  These ads are not too clear on the details and repercussions.  But let me have the honor of doing so:

These types of loan programs were originally designed for the financially savvy and relatively affluent homeowners/ homebuyers who could easily afford to pay the conventional mortgage payments each month, but who would rather use (invest) that money elsewhere.  Towards the goal of a larger return on their money than by merely paying down mortgage principal.

There are numerous problems with this theory.  The most significant is that in today’s market about 90% of the consumers who are electing for these “low payment” mortgage programs are not going to invest any of the savings.  Instead, they are either getting into a home priced well above their means OR they are spending their monthly savings on any number of necessities:  week in Aruba, new 50″ plasma TV, inground pool, etc.  When the low payments end, they cannot afford the newly altered payments AND/OR they have not “saved” any of this found money during the interim in order to pay for their pending shortfall.

And for the 10% of people who legitimately are entering into these types of mortgages, outearning the principal paydown is not as easy at it seems.

If you compare an Interest-Only mortgage with a conventional 30 year amortizing loan, the break-even point is approximately 6%.  If you took all the savings and deposited it into a typical mutual fund (with no sales charges, no maintenance fees, and an expense ratio of 1.75%), this mutual fund would need to average 6% gross ROI per Year (every year) in order to outweigh the amount of Principal paydown you would have paid in a conventional mortgage- after all taxes.  Even if the mutual fund returned an average of 12% per year, your net gain in this transaction would still be under $4,000 (assuming an original loan amount of $250,000- totals taken after 7 years).  And as anyone who has lost a significant amount of money in the stock market would tell you, gaining 12%- or even 6%- is hardly a given.

If you compare the Interest-Only loan to the new Alternative Mortgage Fund (AMF), you will see the results are even more drastic.  If we assume even a 12% annual ROI from the mutual fund invested in, you would still be better off- by OVER $9400 after 7 years- by paying down the loan Principal in the AMF structure than by trying your hand at the Interest-Only mortgage.

Much of the above is due to the fact that the typical Interest-Only mortgage is usually set at 0.35% or 0.40% higher than the similar conventional loan.  So you are paying more for the “privilege” of delaying you loan principal paydown.  But conveniently most of those glossy ads don’t have that fact appearing in bold letters.

I will say that in some (minor) instances, these Interest-Only and Payment-Option mortgages have their place.  But overall, they are another group of products that are promoted to make the mortgage broker and industry a quick dollar- regardless of the potential repercussions.

-KL Mortgage Enterprises, LLC   (amfinfo@comcast.net)

This entry was posted on Sunday, November 19th, 2006 at 10:52 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.