Interest-Only Mortgage Loans

A small but rapidly growing trend in first mortgage products is the interest-only loan. Apparently emboldened by the relentless upward march in home prices, a growing number of consumers have exhibited a preference for interest-only loans, both fixed-rate and adjustable-rate. Because monthly payments are lower on such loans, borrowers can qualify for bigger loans and purchase bigger homes. A recent feature article by Erick Bergquist in the American Banker explained the appeal this way: "With the lower monthly payments you could buy a bigger house, and in a few years, when you're ready to refinance or trade up, you won't be in any worse shape for equity than you would have been if you had taken out a 30-year fixed-rate loan."

Back in January 2003, JP Morgan Chase began offering three interest-only 30-year products with adjustable rates, as well as one with a fixed rate. Tom Garvey, an executive vice president in charge of national production at Chase Manhattan Mortgage (Edison, NJ) told the American Banker that his company had received $250 million of interest-only loan applications in the past few weeks, and "he expects the business line to provide solid growth in the future."

HomeBanc Mortgage Corp (Atlanta, GA) now does about 40% of its annual originations as interest-only adjustable rate mortgages. Patrick Flood, HomeBanc's CEO, said "Its an incredibly efficient way to borrow, an over time these will prove to be less prepayment oriented than fixed-rate conventional loans." Admitting that his prediction was counter-intuitive, he added, "These loans work well because they move with the marketplace. Customers don't refinance them as much as they do fixed. They hang in there, because they think rates will go down again." Of course, that attitude could change if we shift into a protracted rising rate environment. Still, with initial rates as low as 3%, the early savings can offset lots of trepidation about future adjustments, especially if the borrower only plans to stay in the home or mortgage for a few years.