Zero (Low) Payment Loans/Interest-Only Loans

These loans are very, very scary. Homebuyers are increasingly entering into so-called low payment loans as a way to qualifier for more expensive homes. Unfortunately, many of these buyers probably don't fully understand the risks involved in taking on these types of mortgages.

The interest-only loans have the effect of reducing buyers' monthly payments, and allow them to qualify for higher mortgages based on that low initial payment rather than on what they can really afford to purchase at the current interest rate. The mortgages, it must be understood, will change into the mortgage equivalent of train wrecks that can push borrowers into default and foreclosure in a very short period of time.

Interest-only mortgages are set up to require no payment of the principal, thus, you are never actually reducing the your loan balance. This situation is set for a fairly short period of time at a low, fixed interest rate. At the end of the initial loan period, usually 2-3 years, the loans convert into fully amortizing, adjustable-rate mortgages at the current market rates. The principal will now begin being reduced, but because the payback period is shortened, and principal is now included with the interest in the payment, the total costs of the mortgage can rapidly increase by 50-70 percent!

Buyers who barely qualified for the loan at the lower payment amount, now hit with huge increases in the payment amount just 2-3 years into the loan, will be crushed financially. They can try to refinance, but still may not be able to qualify for market rate payments. In short, they could be in way too deep in house debt.

Here is an example of how one of these sordid loans works:

Loan type: 3/1 (fixed period of 36 months)

Loan amount: $350,000

Fixed Period Rate: 4%

Base Date For Loan and Corresponding Rate: September 2004

The initial period payment is $1,167 per month. This is $773 less than the borrower would have to pay on a standard 30-year fixed rate mortgage for the same amount at the September 2004 fixed rate of 5.28 percent.

After 36 months, the payment increases (leaps is a better word) to $2,184 per month, or 79 percent! Keep in mind that interest rates are still very low as we include this example. If rates were higher, this example would be even more breathtaking. If the borrowers who took such a loan kept paying into it, it is estimated that by the 10th year, the owners would be paying close to $2,700 per month. Not a good scenario.