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Mortgage Products: The Interest Only Loan

Many of today's consumers are financing their homes with interest only loans. Not very many of those consumers are aware that some of the grandparents, or great-grandparents also financed their homes with an interest only loan. I myself wasn't aware that this type of loan existed prior to the mortgage market of today. But, we weren't the first to use the interest only concept. During the Roaring 20s, many of middle-America's citizens chose to finance their homes with interest only loans.

Why did they not remain popular, and does this tell us anything about the market of today? Well, let's take a moment to examine the interest only loan of the 20s compared to the loan of today, and maybe we can become better educated shoppers.

The interest only loan of the 20s was a pure product. This means that the mortgages were interest only for the life of the loan. At the end of the mortgage period, nothing had been paid against the principal. Only the interest payments against the principal borrowed had been paid. This worked really well until the crash of the stock market and the Depression. At this point, many of the families that had lived in homes paying only the interest due were forced from their homes when there was no money and no jobs. Many lending institutions were left with foreclosed mortgages, and no cash. The traditional lending institutions at this point, simply shelved the interest only loan, in favor of more equitable lending; in other words, they preferred to loan money for a mortgage that would build equity. This gave the homeowner something comparable to savings, and the banker a lower outstanding mortgage balance.

That is a lesson we should carry forth when lending today, and using the interest only option. Most of the products offered today do carry a limit for the term of the interest only element. Generally, if the loan is a 30 year loan, no more than half can be used towards the interest only option. At least someone has exercised some level of judgment in providing for a cap, or limit to the interest only term.

In today's society, everything we see encourages instant gratification, and home mortgages are no different. Instead of sending a message that says, if you want more house, you need more money, we send the message that it's ok to borrow beyond your means. Now, in all fairness, there are some mortgage shoppers that fit the description of the candidate for the interest only loan. Investors, and candidates who do not intend to keep a home for longer than 5 years, do benefit from the interest only loan option. But for the typical homeowner, the interest only mortgage only prolongs the equity building process, and may often put the borrower in a situation where he or she cannot actually afford the payment when the principal and interest period begin.

Thanks to the booming real estate market, the interest only loan option, and the expansion of the mortgage product market, the increase in purchasing power has enabled many prospective homeowners to actually make a dream a reality. But at some point, the market will cease to boom, and the mortgage market will cease to expand. Will the consumer that purchased the interest only loan be able to afford the consequences, should the home suddenly not be worth the original loan amount? Let's hope for the sake of the unwary homeowner, this is a situation we do not soon encounter. And, for the most part, I don't believe we'll see this any time soon. Thanks to the natural disasters along the gulf coast, and the continued demand for real estate and building materials, the housing prices we're currently experiencing, along with the growth we've seen for the past couple of years, should continue at the same rate.

There are other, more stable loan products available, but these products don't provide the kind of return for the mortgage lender that the interest only loans do. They also don't pose the risk the interest only loans pose. The interest rates, however, are very competitive on these loans, and I don't' look for the general public to decide in favor of safety over savings. After all, nothing ventured, nothing gained.