Metro Denver ranks fourth among the nation’s biggest urban regions in the percentage of mortgage loans for homes bought in 2004 that featured interest-only payments.
That’s a dubious distinction at best, real estate experts say.
The cities ranked ahead of Denver are San Diego, Atlanta and San Francisco, according to LoanPerformance, a San Francisco real estate information service.
In Denver, 43.4 percent of loans last year were interest only. In San Diego, 47.6 percent of home loans had interest-only payments.
“Interest-only loans are not the demons they’re made out to be for the savvy borrower who wants them,” said Tim McDonald, a regional vice president of Wells Fargo Home Mortgage. “But they are really as bad as everyone says for people who must have them to buy a home.”
Most borrowers taking out interest-only loans couldn’t afford their homes without them, financial experts say.
Interest-only mortgages start with a period – typically three, five or seven years – during which borrowers have a fixed interest rate and don’t have to pay to reduce the principal. The loans eventually convert to either fixed- or adjustable-rate mortgages that require borrowers to repay principal and interest. That interest rate could rise sharply with the market or from the original interest rate.
Interest-only borrowers are gambling in many respects, said Ruth Hayden, a financial author and educator in St. Paul, Minn.
They bet their income will have grown enough to handle the higher principal and interest payments or that they will refinance the loan at a more favorable interest rate, she said. Borrowers also might plan on the home’s value increasing enough to allow them to sell at a profit before higher payments kick in.
“The threat of higher interest rates is creating a home-buying frenzy that reminds me of the stock market run-up of the late 1990s,” Hayden said. “People think that if they don’t get in the market now, they never will. The tragic thing is that they’re overreaching, and their homes are at stake.”
Hayden also warns that interest-only loans can prevent borrowers from building equity if the home’s value doesn’t rise. If real estate prices fall, borrowers could wind up owing more than their homes are worth.
That’s what happened during the Great Depression. The drop in home prices sent foreclosure rates soaring and prompted lenders to stop selling interest-only mortgages. They were reintroduced in the United States about five years ago.
Lenders say interest-only loans are cheaper and allow borrowers to take the money they would have spent on principal and invest it elsewhere.
For example, a borrower with a $250,000 fixed-rate, 30-year mortgage at the Denver metro region’s current 5.35 percent average interest rate would pay $1,396 a month in principal and interest. Borrowers paying interest only for five years with a 5.25 percent interest rate would pay $1,094 a month – a difference of $302 a month.
If borrowers used that money to pay down the loan’s principal or repay consumer debt, such as credit cards and auto loans, they could come out ahead. But many – if not most – use the “savings” unwisely, said Mike Ballou, a senior loan officer for CDC Financial.
“Human nature is what it is,” he said. “Some people have the discipline to act responsibly, and others buy things” they don’t need.
Hayden takes it a step further. She suspects most interest-only borrowers can’t afford to pay down principal or consumer debt.
“People who can afford to pay principal and interest do not need interest-only loans,” she said.
Ballou, Hayden and McDonald said they do not typically recommend interest-only loans to first-time buyers or to buyers with fixed incomes. They said they are also wary of interest-only loans that contain prepayment penalties for borrowers who want to repay principal ahead of schedule.
Staff writer Christine Tatum can be reached at 303-820-1015 or ctatum@denverpost.com.
