6 Reasons to Avoid Option Ajustible Rate Mortgages (ARMs) & Interest-Only Loans

Interest-only loans and Option ARMs are two of the most dangerous mortgage options available out there. These types of mortagages cater for people who cannot afford the monthly payments on 30 year fixed term mortgages. Instead, these loans allow these people to make only the minimum interest payments every month, thus allowing them to fulfill their "American dream." Most of these sub-prime borrowers take out an interest-only loan because:

i) None of the principal mortgage balance is to be repaid within the first 5-10 years of the mortgage contract

ii) Interest-only loans offer introductory interest rates that are lower than those provided by a fixed-rate mortgage

After the introductory rate period is over, mortgage payments owed by these borrowers shoot up high. These borrowers cannot come up with the extra money needed to cover the increase in their monthly payments, nor are they allowed to refinance their mortgages, nor are they able to sell their houses. That's why we currently have an epidemic in the American mortgage industry; many people are losing their homes to foreclosures. You do not want to become a foreclosure statistic.

Here are 6 logic reasons to avoid interest-only and Option ARM mortgages

1) You Still Owe that Mortgage Debt

If you take out a mortgage loan for $250,000 and make interest payments on it for 5 years, you will still owe $250,000 at the end of those 5 years. None of those interest payments you make will be applied towards building a nest egg or equity in the house, it goes to fulfill the interest charges. This is another sophisticated version of renting.

2) You Can't Sell

A large # of interest-only loan borrowers cannot sell their homes because selling a home requires money. To sell a home, you need atleast 10% of the price to be able to pay your realtor's fees as well as closing costs, bank fees, etc. For example, consider you purchased a $300,000 home and paid $15,000 down payment for it. And consider you sold the house for a hypothetical price of $300,000. Here's how the money would be divided:

3) Home Prices are Not Going Up

Many interest-only loan borrowers cannot refinance their homes because they do not have enough equity built into their homes. As well, most of these borrowers hope that home prices go higher in value so that they can sell their houses for a good profit and be able to build equity in their homes. This was true between 2001 and 2005 when house prices went up by 51%. However, home prices are now stagnant, infact they are falling everywhere in the country. Some cities such as California are reporting a 10% decline in house prices in 2007. Therefore, counting on home prices going up so as to build equity in your home is not the way to go.

4) You Can't Refinance

Many interest-only loan borrowers hope to refinance their loans for a better interest rate after their introductory interest period is over. Be aware that refinancing a loan is never guaranteed. Infact, many interest-only loan borrowers cannot refinance their homes because mortgage lenders ask for higher incomes, less debt, better credit histories as well as having equity built into their homes, atleast 10%.

If borrowers fall short of these rules, they will end up with a mortgage refinancing loan that is pretty much the same as their existing interest-only loans with higher interest rates. Therefore, it will not be the best option.

5) Most Interest-Only loans are adjustable-rate loans

When the introductory interest period is over, the interest rate resets itself, usually 2 percentage points higher. At this time, the borrower is also expected to repay for the original principal balance. Not only will the borrower have to pay 2% extra interest every month, the borrower will also have to begin repaying his original principal balance. Now we can determine why there are so many foreclosures happening in the USA, it's because of this double blow that borrowers are facing.

6) You Won't Reduce Your Mortgage

It's easy to convince oneself that I will make extra payments every month towards the mortgage so as to pay it off faster. But it's also easy to convince onself that I will go on a diet with no sugar, no fats, etc as well as go for a 2km jog every morning. Some people will abide by their promises and do it, most others won't. Therefore, most interest-only loan borrowers cannot pay extra towards their mortgage balance because they don't really have the money for it.