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After 3½ years, the money the customer would have spent on payments is ready for the next option. If the rate on the debt is more than the mortgage rate, then this loan is ideal. In addition, unlike credit card debt, home-mortgage interest is tax-deductible.
Homeowners in the know
Homeowners are proving they are smart enough to receive the minimum-repayment requirements and then take care of paying off the loan on their own terms. When looking at a 30-year interest-only loan, homeowners are asking: Is it smart to pay off my home? Do I need to pay it off now? Are there other uses for the money that would go to amortization? Is my 401(k) more important than repaying my home?
After looking at rising equity levels, rising income and the performance of other investment opportunities, many borrowers would rather put their money to work for them than pay off their homes. However, this only works if they know how to make smart decisions about the loans.
For example, if Joe Homeowner has $100,000 available in his home that can be accessed through an interest-only loan, it will help put the equity to full use. He can get a fixed loan with a 6-percent rate and invest the amount into a mutual fund with a return greater than the annual percentage rate, and he would gain financially. If invested carefully, performing funds can return a sizable profit compared to the 6-percent rate. This low monthly payment allows him to borrow money for investing and still make a good return and amortize the payment later.
Homeowners also are aware that their earnings will improve with time. They also know that they will be more capable of paying off their principal as their salary increases or as they encounter financial windfalls. After combining this with any further increase in home value, many of today's consumers are comfortable taking a loan that gives them control over amortization and their finances overall. They must be warned, however, that if these scenarios do not happen, the loan option could backfire if not used and managed properly.
Showing borrowers their options
Brokers must take an active role in educating themselves and borrowers on these loans and understanding the advantages and disadvantages before proceeding.
Usually, interest-only loans are straightforward -- the homeowner pays an amortized payment or just the interest. Customers might need help understanding their options in repaying the principal. In contrast, homeowners may have an interest-only loan in mind, but their goals might make an option-ARM loan better suited for their situation. Educating is not only explaining how the loan works but also helping borrowers analyze their situation and goals to identify the best loan program for their needs.
Sitting down with a payment calculator and a calendar to create a payment schedule can quickly show borrowers their options and what to expect. One of the most-important factors with an interest-only or option-ARM loan is to have a plan. This can include paying the amortized amount every month with allowances for tight months as the exception or paying only interest for a few years.
More potential homeowners are proactively taking advantage of alternative options available in our industry. Borrowers are moving away from holding their brokers' hands and are pursuing the best option for their individual needs. They are demanding to explore interest-only and option-ARM loans. In turn, we should demand greater knowledge of the products from ourselves. If we cannot help borrowers, they will find someone else who will.
Although many in the industry are apprehensive about the performance of interest-only and option-ARM loans when rates rise, the products are valuable tools for consumers. They should gain even more consumer acceptance and demand as the industry moves away from the refinance boom and into a marketplace where consumers already have a low first mortgage but need extra money.
As mortgage professionals, we should not only be prepared for customers to request these loans, but we should also be prepared to help them use their knowledge and options to their fullest advantage.
Lorne Lahodny is president of Costa Mesa, Calif.-based
Secured Funding Corp., a full-service retail and wholesale lender specializing in second mortgages. For more information, contact Lahodny at (714) 689-6696 or firstname.lastname@example.org.
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