Interest Only Loans got a Bad Reputation Last Decade, But They are Still Perfect for Some Mortgage Borrowers.
For normal homeowners, the term “interest only” mortgages might make them cringe. The point of buying a home is to actually get it paid off so it’s yours, free and clear. Paying only the interest for any designated amount of years seems to defeat that American dream of owning your own house.
Plus, interest only mortgages got a really bad reputation for playing a big part in the financial crisis of 2008 and 2009. Loose underwriting and people trying to buy more house than they could with interest only loans made these mortgages dirty little scoundrels for a few years.
How to Qualify for an Interest Only Mortgage
But yes, interest only mortgages are back for a very specified and wealthier group of people and investors. It allows lower monthly payments – for a while – and lets the borrowers free up their cash for other reasons.
“To me, it’s a no brainer. This is prudent lending to savvy buyers,” says Mat Ishbia, president and CEO of United Wholesale Mortgage, headquartered in Troy, Mich.
His company just began offering this product a month ago. But other companies also offer them.
“For us, borrowers must have at least 20 percent down, a FICO score of at least 720 and a 42 debt-to-income ratio. We also require them to have 24 months of reserves,” he says.
That means if someone is going to have $3,000 a month payments, they have to have $72,000 stored in the bank for reserves. These requirements are much higher than most conventional loans.
“Just in the last couple of weeks, we just got our first handful of loans through. We get the cream of the crop of borrowers. Some are putting 60 percent down and have 760 credit scores or higher with $1 million in the bank,” he says. “It’s the right product for the right people.”
Interest Only Mortgage Availability
The loan begins as a five-year adjustable-rate mortgage – meaning it has a low interest rate for those five years but will increase at the end if they don’t refinance or pay it all off by then. Ishbia says that borrowers for these niche loans are underwritten about 2 percent above the interest rate to make sure they can handle a bigger increase.
Ninety-percent of all borrowers would be turned down for interest only mortgages, he states. And also Freddie Mac and Fannie Mae no longer do these type of loans, so a couple of Wall Street investors work on the back end buying these loans.
“Most large banks do offer these no-interest loans. But they don’t market it out publicly. We’re just bringing it back more mainstream for mortgage brokers to offer it to their clients,” he says. “A lot of jumbo loan clients are looking into it.”
An example of one of Ishbia’s recent clients is someone with a 775 credit score, $500,000 in the bank and makes $250,000 a year. He was able to put 40 percent down. He receives an $80,000 to $100,000 bonus every December from his job and will be able then to put down a big chunk of the principal but didn’t want to miss out on a deal at this time of the year.
“Some of what is happening these days is the specialty niche products are coming out where it might be appropriate,” says Julia Gordon, senior director of housing and consumer finance at the Center for American Progress in Washington, D.C. “These loans are not eligible for the super safe category that gives lenders more legal protection. At least these days, lenders will be accountable if they give these loans to the wrong people.”
Interest Only Mortgages Reborn
Lending companies do want to offer tailored products to their customers, and they should be able to do that as long as they do it with their eyes wide open and the consumers’ eyes are wide open, she comments. Interest only mortgages are definitely not meant for broad-based homeownership.
Before the housing collapse, affordability was an enormous part of the equation on why these loans became popular. Lots of lenders were pushing products such as interest only loans because they were riskier.
“Products that were riskier were paying the lenders more money (as long as they were performing) from the secondary market,” she says. “There wasn’t a wide spread demand from consumers wanting interest only mortgages.”
But magically, a lot of these loans were signed, and hence, many people defaulted on them when the home values dropped drastically and homeowners couldn’t refinance or afford to add in their principal payments.
“Personally, I don’t think interest only loans are a great idea. But then again, I only own one house. I didn’t take advantage of buying investment homes. But there are people out there that have the means and ability and desire to do this,” she says. “It’s OK if these loans are happening among sophisticated parties.”