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Are Interest-only Home Loans Good For Military Families?

Movers deliver household goods for a Navy family at Ford Island, Pearl Harbor. (Photo: U.S. Navy)
Movers deliver household goods for a Navy family at Ford Island, Pearl Harbor. (Photo: U.S. Navy)

Recently, interes- only home  loans received plenty of negative press. The criticisms focus on the  supposition that homebuyers will never make principle payments, and thus, never  build equity in a home or own a home. Additionally, criticisms extend to loose  underwriting practices and unacceptable increases in monthly payments at the  end of the adjustable rate. All of these critiques have some validity, but  there are times when interest-only home loans are an 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 in  the interest rate for the initial term of the loan, which can last one, three,  five, seven or 10 years. At the end of the initial term, the rates will usually  adjust upward. For example, a 6 percent, 5/1 interest only ARM means that for  the first five years, the buyer will pay interest only at percent. 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 conventionalloan 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 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 versus traditional conventional loans

Interest-only Loan  Amount of $300,000 at 6 percent 5/1 interest only ARM The monthly payment is  $1,500

Traditional Conventional Loan  Loan  Amount of $300,000 at 5.5 percent 5/1 ARM for 30 years The monthly payment is  $1,703

The difference between both loans is $203 per 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:  

  1. When you do not expect  to stay in the home beyond the initial ARM period.
  2.  
  3. When you are buying in  an area where you can reasonably expect homes to appreciate at a modest to  above average rate.
  4.  
  5. When the reduced monthly  payment is required to qualify for the loan.
  6.  
  7. For budget  flexibility. 

  Finally, everyone is aware of  the tax advantage that home ownership provides over renting -- homeowners can deduct the loan interest. Some disciplined military home owners have found that  interest only loans gave them the opportunity to 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.)  However, interest only loans are probably  not the optimum choice for homebuyers 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. 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.  They can be contacted at homesformilitary@vrsam.com.  (Licensed in Virginia under Jobin Realty brokerage.) Show Full Article