IS AN “INTEREST ONLY” HOME LOAN A GOOD CHOICE FOR THE MILITARY FAMILY?
By Captain Joe Gladden (USN, retired)
“Veteran Realtors Serving America’s Military,” Inc. VR SAM®
Recently “interest only” home loans have received a lot of press, most of it negative. Generally the criticisms focus on the supposition that home buyers will never make principle payments, and thus never build equity in, or own their home. Other criticism is directed at loose underwriting practices and unacceptable increases in monthly payments at the end of the adjustable rate period, which of course, are legitimate concerns for all loan products. All of these criticisms have some validity, but there are clearly times when “interest only” home loans are a very appropriate choice for military families.
First, let’s compare the structure of the “interest only” loan to a “traditional conventional loan.”
As the name implies, the “interest only” loan requires interest payments only on the loan balance. Most (if not all) “interest only loans” are also Adjustable Rate Mortgages, or ARMS. ARMS lock the interest rate for the initial term of the loan, generally one, three, five, or even seven or ten years. At the end of the initial term, the rates will usually adjust upward. Example: A 6%, 5/1 “interest only ARM” means that for the first five years, the buyer will pay interest only at 6%. Most “interest only” loan products do not have a prepayment penalty.Thus, if you make additional payments on the principle loan balance, your subsequent monthly payments will be reduced because the loan amount has decreased!
In contrast, the more “traditional conventional” loan requires interest payments on the unpaid loan balance in addition to amortized principle payments over a specified period, usually 30 years. The monthly payment remains the same, but the amount paid towards the loan balance gradually increases while the amount of interest paid gradually decreases over the life of the loan. The traditional conventional” loan can either have a fixed rate for the life of the loan OR be an ARM with terms similar to “interest only” ARMs. Note that the actual interest rate on the “traditional conventional” loan will usually be slightly lower than on the “interest only” loan products.
Example Comparison of “Interest Only” vs. “Traditional Conventional” Loans
Interest Only Loan
Loan Amount $300,000, 6%, 5/1 interest only ARM. Monthly Payment: $1500
Traditional Conventional Loan
Loan Amount $300,000, 5.5%, 5/1 ARM, 30 yr. Monthly Payment $1703
Difference: $203 / month
Note: For comparison purposes, examples DO NOT include property taxes, hazard insurance, condo or homeowners association fees.
Military families should consider Interest Only loans:
When you do not expect to stay in the home beyond the initial ARM period.
When you are buying in an area where you can reasonably expect homes to appreciate at a modest to above average rate.
When the reduced monthly payment is required to qualify for the loan.
For budget flexibility.
Finally, everyone is aware of the tax advantage of home ownership over renting in that you are usually allowed to deduct the loan interest. Some disciplined military home owners have found that interest only loans have given them the opportunity commit the difference in monthly payments ($203 in our example) to a tax advantaged retirement vehicle, such as a 401K, IRA, or TSP. (Check with your accountant and financial planner!) Interest only loans are probably not the optimum choice for home buyers who intend to live in the home for lengthy periods or who desire to ultimately pay the loan off.
Regardless of the type of loan, there is no substitute for financial discipline and thoughtful budgeting. You should carefully select your loan company and loan officer. All loan products should be thoroughly understood before signing on the dotted line. And remember, home loans are to BUY HOMES! There are numerous perils associated with equity loans and rolling consumer debt into “the roof over your head!”
Veteran Realtors Serving America’s Military, Inc. is a Realtor Team dedicated to serving Military Housing needs in Northern Virginia and DC area. (Licensed in Virginia under Jobin Realty brokerage.)