Interest-only mortgages

[nathan]

Hey Guys,
Recently, Interest-only mortgages have been becoming popular, and I'm curious to know what others think of them. If you're unfamiliar with the concept, it's this:
The borrower gets a favorable rate, however 100% of the payment goes to interest, and 0% goes towards equity. To make things even more "interesting," there is often a 5-year balloon payment.

The idea behind this mortgage is that a borrower can afford a lower payment, and use capital gains during the first five years so that the value of the property will be enough to re-finance with a traditional mortgage so they can begin to build equity, OR sell the property.

The obvious risk to the borrower is what happens if after five years there has NOT been significant increase in the value of the real estate they've purchased. Then they're stuck with a balloon payment and no equity in their property.

Furthermore, from an economic standpoint, what happens if a lot of these mortgages are obtained around the same time (like NOW). In five years from now, when balloon payments come due, will there be a sell-off of real estate, causing a downturn in the market?
Good luck

[samuel]

Hey Nathan,
I personally think they are too much of a risk but I'm a bit conservative on these kinds of things. You never know what the market will be like in 5 years when you are forced to either refinance or sell. From my experience, people sometimes use this type of financing to purchase a home that is actually beyond their means. They feel that since the payment is lower they can buy more home. In the end if you're not careful it could cause you more problems than it's worth!
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