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Interest Only Mtge - Reasons/Risks?


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Guest pieper

I am troubled by an interest only mortgage which my boyfriend has on his home, purchased approximately 3 months ago (before I was involved deeply). The home has an approximate value of $600K - $700K in the Los Angeles area, and he's got an interest-only mortgage of $550K. The home needs significant work in terms of updating. Perhaps up to $50K or more. When I asked to take a look at the actual mortgage docs, he wasn't able to locate them. He makes approx $120K/yr and has been divorced for less than 3 years (which might explain lack of cash for a down payment/standard mortgage) and has alimony and support payments, as well as heavy credit card debt. He's in the contracting business, so the intent was to flip the house within a few years, max. He's owned and flipped homes previously, although I have no sense of the "success" of those transactions. Nor do I have any good inkling of his credit rating or position.

I suppose my concern is simply a lack of understanding about the no-interest vehicle, common problems/pitfalls, and conversely the UP-side of them.

Any simple input on this situation or recommended resources? If additional info is needed, I'll be happy to provide it as best I can.

Thanks!

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Interest only loans were popular before the depression- the big pitfall is this:

it makes certain assumptions that may or may not be true, the largest being that your income will increase enough to cover the higher payment when the loan term is up. Since you are not paying any principal, you owe the same amount on the house that you owed when you started. The assumption that your friend is making is that the value of the house will go up enough to cover his costs when he sells it.

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The pitfalls are as follows:

Most mortgages are based on a repayment of the total loaned amount plus interest in 30 years. So, Lets say that his credit was decent and he has a conforming I/O loan. The I/O term is probably 10 years. He and everyone else realizes that in 10 years his payments will go up to start covering the principal. Here is the other part that most LO's don't explain. At the end of 10 years he has to pay back the entire owed amount in the next 20 years. So the payments REALLY go up.

I would suggest that he start paying the "normal" amount of principal due, now.

Every one in the financial world knows that the average loan is only kept for 5-7 years. So chances are great that he can refinance in that time and everything will be great. The only problem is that whereas long term real estate values go up, sometimes short term they will go down a bit.

Southern California is a great example. About 10 years ago people seemed to want to leave the area and prices went down a lot. Then about 5 years ago those people went back. Prices went back up. About the first of the year they went down again and now they are edging up. You can see the picture. If you HAVE to sell or refinance at a dip you will have a problem.

I hope that everything works out as he has planned and he can sell at a profit in a year or so.

Charles

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