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Ask our broker Interest-Only Loans:Good for Some,Sometimes

QandA WITH PETER G. MILLER
BY CHARLES SCUTT
Content That Works

Borrowers looking to stretch

lar – an interest-only loan – pro-
vided they fit the right criteria.
A popular alternative to tradi-
tional fixed-rate mortgages, inter-
their mortgage dollars may bene- est-only mortgage loans enable a
Pay Less Now, or Maybe a Lot fit from a loan vehicle that is home buyer to make payments
proving to be increasingly popu- on only the interest over a
More Later: Which Loan
Should I Choose?
defined period of time – typically
the loan’s first 3, 5, 7 or 10 years.
After this interest-only period,
the principal must be repaid
est-only mortgage loans come in
many different varieties, and can
be 30-year fixed-rate mortgages
or adjustable-rate mortgages
over the remaining term of the (ARMs). An interest-only ARM
loan.
Like regular mortgages, inter- See INTEREST-ONLY, Page 2

Getty Images
Q: I’d like to purchase a home
and I can afford to buy with a
$300,000 adjustable-rate mortgage
(ARM). But as much as I want to
buy – and I really, really want to
buy – I do not have enough
income to purchase with a fixed-
rate loan of the same size. My worry about the
ARM is that payments may go up to the point
where they’re painful. What do I do?

A: Buy less.There’s no rule or law that says you have

to buy the most expensive home you can afford – or
barely afford.
Let’s look at the marketplace.As this is written fixed-
rate mortgage interest is roughly 5.56%.This is about as
low as rates have been in four decades. Over 30 years,
the cost for your $300,000 mortgage would be $1,715
per month for principal and interest.
ARM start rates are now at about 4.25 percent so
your initial monthly cost for principal and interest
would be $1,476.You would save almost $240 a month
or $2,880 a year. But the ARM rate is a “start” rate. It
could change.
If the ARM rate goes up 1.3 points you’re paying as
much as the fixed-rate borrower. If it goes up further,
you’re paying more – plus you’ve lost the chance to
lock in a low fixed rate.Worse,ARM rates are usually
allowed to rise 5 or 6 percent above the start rate. How
would you feel about a loan at 10.25 percent? On
$300,000 you’d be paying $2,688 a month for principal
and interest.
In addition to principal and interest, you also must
pay property insurance and taxes whether a loan is
fixed or flexible.These are expenses which also rise
over time.And don’t forget, bigger homes cost more to
heat, air condition and maintain. Pack up all your cares:Water is the most common cause of home damage. Before leaving home for vacation or an extended trip, check the water heater and appli-
ances for possible leaks, be sure faucets are firmly turned off and consider having a friend stop in regularly to check the premises.
There’s no sense being house poor or buying a home
you can’t enjoy. If $300,000 is too much to borrow,
that’s okay. Look for a smaller home, a property with a
less prestigious address, a home a little further out or a
house in need of some repair. For more information, Water Ranks as Homeowners’ No. 1 Headache
speak with local brokers.
BY PAUL ROGERS Carpets, walls, doors, furniture, even parts “Water is the most common cause of
Content That Works of the ceiling were completely ruined.The home damage today – even more likely than
Q: My brother and I will soon inherit proper- humidity that had been building while the fire,” says Jim Swegle, vice president of per-
ty. He will want to sell and I will want to keep it.

W
hen Jeff Hunkele and Megan
It’s an old family house that I want for the next Woodward returned home to their
generation. What can we do? duplex condo in Chicago after a hol-
iday visit to the relatives, they were greeted
with an unwelcome surprise. Sometime early in
See ASK OUR BROKER, Page 2 their 10-day trip, a water pipe had burst, satu-
rating the entire basement level – and the
water was still flowing.
homeowners were gone wreaked havoc on
the upper level, too, warping the wood floors
and swelling cabinets.As they dried, the cabi-
nets pulled granite countertops away from
the walls. Damage, when all was said and
done, exceeded $15,000.
Unfortunately, Hunkele and Woodward are
not alone.
sonal property for Seattle-based Safeco
Insurance.“Americans are spending twice
what they were 10 years ago to repair water
damage.”
From 1998 to 2002 alone, the average cost
for a claim from water damage or freezing
See WATER, Page 2

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WATER
CONTINUED FROM PAGE 1
rose 38 percent, from $2,519 to
$3,469, according to the Chubb
Group of Insurance Cos.,
Warren, N.J. Safeco sets the aver-
age water damage claim even
higher at $5,000.
And insurance companies
may not cover all costs. More
than half of homeowners sur-
veyed by Chubb who experi-
enced water damage said their
insurance did not cover or only
minimally covered the repairs.
In addition, pipes aren’t the
only potential problem area.A
Safeco analysis of water damage
claims from approximately 1 mil-
lion homeowners in 44 states
found that although 62 percent
were due to faulty plumbing and
8 percent to weather, the
remaining 30 percent came from
appliance failure.
The main culprits:Washing
machines and hot water tanks,
which together account for one
of every 10 claims, followed by
refrigerators with water or ice
dispensers, dishwashers and attic
air conditioning units.
“Homeowners can save them-
selves a lot of time and money
by adding a few simple protec-
tive devices and doing routine
maintenance,” says Swegle.
“These tasks usually take just a
few minutes and the parts often
cost less than $20.”
To minimize your chances off
coming home to a flooded
home, water damage experts at
Safeco, Chubb and State Farm
Insurance Co., Bloomington, Ill.,
recommend the following meas-
ures:
* Introduce heat to exposed
pipes in cold areas by opening
access doors.
* Set thermostats at a mini-
mum of 65 degrees Fahrenheit
* Drain and shut off pipes
flowing to outside faucets.
* Inspect washing machine
hoses regularly for wetness
around the ends and signs of
bulging, cracking or fraying.
* Inspect toilets, sinks and
bathtubs, paying special atten-
tion to cracks or mold on caulk-
ing and grout and for leaks in
water supply lines.
* Inspect water heaters, look-
ing for wet spots on the floor or
rust. Most water heaters need to
be replaced every 10-15 years.
* Inspect dishwashers and
refrigerators, looking for discol-
ored, warped or soft flooring,
and water damage to nearby cab-
inets.
* If you’re going to be gone
for an extended period of time,
completely turn off the water
supply or enlist a friend to check
on your home daily for heating
malfunctions or frozen pipes.
* Test the sump pump before
the start of each wet season and
invest in a battery-powered
backup in case of electrical out-
ages.
Water precautions are particu-
larly important to today’s home-
owners because of the rise in
high-cost items present in a
house: computers, home theater
systems, custom maple cabinets
and hardwood floors. Kitchens
have come a long way from
Formica countertops and
linoleum.
People interested in the latest
home electronics might want to
go one technological step fur-
ther to protect them. Companies
like Liquid Breaker, Carlsbad,
Calif., Dorlen Products Inc.,
Milwaukee,Wis., and Absolute
Automation Inc., Casco, Mich.,
offer water detection systems
designed to warn homeowners
of leaks or, more broadly, moni-
tor the water systems in a build-
ing.
According to Chubb, only 3
percent of homes have installed
moisture or water detection sys-
tems. Even if you prefer to stay
in the other 97 percent, keeping
an eye on the water supply can
save you significant costs and
loss of property. Routine mainte-
nance can mean the difference
between a $20 fix and a $5,000
water damage claim.
© Content That Works
Ask our broker
CONTINUED FROM PAGE 1
A: If you’re both owners it’s likely that he will be
able to seek “partition” and force a sale. However, can
you buy out his share? Could the purchase of his inter-
est be financed by getting a new loan on the property?
Plan ahead. Have financing and an offer in place
before a fight develops. Quick and easy cash for him
and ownership for you without a fight would be good
for everyone.
Q: We’re refinancing our home. Because the
loan-to-value ratio is less than 80 percent we
have the option of allowing the lender to set up
an escrow account to collect property taxes and
insurance or we can do it ourselves. Which is bet-
ter?
A: Suppose taxes and insurance amount to $3,600
annually. If you want to have an escrow account, the
lender will collect an extra $300 a month and then pay
the tax and insurance bills as they come due.
One way or another you’ve got to pay taxes and
insurance.The mortgage requires you to pay taxes and
to have fire, theft and liability insurance. Don’t pay and
you can have real problems with the local government
– it can sell the property for taxes. Don’t pay and the
lender can foreclose because the terms of the mortgage
are not being met. Usually, the lender simply obtains
insurance for you – although maybe not be coverage
with the best possible terms and premiums.
If you know with absolute confidence that you will
always have the money available to cover big payments
for taxes and insurance, then you can consider not hav-
ing an escrow fund. But as a matter of convenience and
certainty, an escrow account is simply a better idea for
most borrowers.

Q: I want to buy a new townhouse to rent out

but the developer will only sell to owner-occu-
pants. Is there any way for me to get around this?

A: No. If too many units are rented, lenders may

INTEREST-ONLY
CONTINUED FROM PAGE 1
often will have a period where
the interest rate is fixed (for
example, the first five years of a
30-year loan, during which inter-
est only is paid), and then it is
adjusted yearly. An interest-only
ARM also has a maximum inter-
est rate that it cannot surpass.
The advantages of an interest-
only loan include lower monthly
payments, an improved ability to
qualify for larger loan amounts,
the opportunity to buy a more
expensive “dream house,” and an
easing of monthly cash flow
pressure, says David Brown, pres-
ident of Premium Capital
Funding, a full-service mortgage
provider based in Jericho, N.Y.
The extra borrowing power is
substantial, says Nicholas Buss,
commercial real estate econo-
mist for PNC Real Estate
Finance, based in Pittsburgh,
Penn.
“Let’s say you had budgeted
$2,200 per month for housing,
not including tax and insurance,”
Buss says.“If you took a standard
fixed-rate 30-year mortgage at
the current 5.75 percent rate,
you could borrow $380,000. But
if you took a 5/1 interest-only
adjustable rate mortgage at the
current 5.25 percent, you could
borrow $500,000.”
At the end of the five-year
interest-only period in this exam-
ple, however,“monthly payments
could jump significantly,” notes
Buss.“At that time, the interest
rate adjusts and you start to pay
down the principal – but, the
principal is amortized over the
remaining 25-year period, not 30
years.Assuming interest rates
stayed flat – at 5.25 percent –
the monthly payment would
jump from the original $2,200 to
$3,000. If interest rates rose from
1percent to 6.25 percent, then
the payment would jump to
$3,300 – or an increase of 50
percent. How many households
could withstand this increase?”
Increased monthly payments
aren’t the only pitfall to interest-
only loans, Buss says.“You are
paying no principal - essentially,
it is a like a lease or rent pay-
ment.The only equity you build
is equity through appreciation,
assuming there is some.”
An interest-only loan can
make sense for borrowers who
plan to sell their home or refi-
nance before the fixed-rate inter-
est-only period expires.
“But what happens if home
prices readjust and at the time of
sale at the end of five years the
home is now worth 10percent
less than when you bought it?”
Buss says. Using the previous
example,“assuming you lever-
aged up and only put 5 percent
down, you now have a home
worth $472,500, but a mortgage
of $500,000 to pay off and/or
refinance.”
Experts say that interest-only
loans are suitable for buyers
planning short-term holds and
who are confident that the mar-
ket will not depreciate during
that period.They may also be
viable options for buyers who
can afford higher payments, but
for whatever reason want to use
that money for other invest-
ments or purposes near-term.
“For investors, interest-only
mortgages allow you to spread
your investment dollar further.
The name of the game here is to
make money through the contin-
ued appreciation of home values
– you want to do this by tying
up as little cash as possible.
These loans offer the best way to
do this.And it works, as long as
home values continue to rise,”
Buss notes.
In a growing number of
expensive markets, such as high-
priced California cities, an inter-
est-only loan is often the only
way many households can break
into home ownership, says Buss.
“But, for the most part, these
are risky instruments that essen-
tially make borrowers very vul-
nerable to market timing,” Buss
regard the entire project as “commercial” real estate.
That will mean higher rates and more down for all buy-
ers – and thus potentially fewer sales and lower prices.
The developer is protecting both his interests and
those of the unit owners generally.
© Content That Works
Do you have a question or a quandary about buying, sell-
ing or renting? Peter G. Miller, author of The Common-Sense
Mortgage, specializes in providing real solutions to real estate
dilemmas. E-mail your questions to
continues. peter@contentthatworks.com.
Avoid at all costs interest-only
loans that have a balloon pay-
ment as opposed to an
adjustable rate mortgage provi-
sion, says Norm Bour, radio host
of “The Real Estate and Finance
Show,” heard in Southern
California on KRLA, 870 AM.
Additionally,“understand the
index being used for the ARM,
know your spread, make sure
there are caps in place for annu-
al increases and/or total increas-
es in rates, and know what hap-
pens and what your payment is
likely to be at the end of the
interest-only period. Bottom-line
– do your research, shop around,
ask questions, and be knowl-
edgeable,” says Buss.
The danger of interest-only
loans lies when they are utilized
outside of a comprehensive
financial strategy, says Gibran
Nicholas, president of Nicholas
& Co. Mortgage Planners in Ann
Arbor, Mich.Therefore,“con-
sumers should shop for a mort-
gage professional who can give
them the proper guidance ver-
sus shopping for the elusive low-
est rate, which can often be the
wrong financial strategy,” says
Nicholas.
Kevin Daum, founder and
CEO of Stratford Financial
Services in San Francisco, warns
against contradicting your
approach for your mortgage.“For
example, don’t take an interest-
only loan and then set up to
reduce the principle in an accel-
erated program, such as a bi-
weekly payment system.”
Also,“don’t make a decision
on the type of loan program and
size of the loan without consid-
ering all of the factors of your
finances, including tax issues and
your investment diversification
strategy,” Daum says.“Educate
yourself so you can make a
knowledgeable choice.”
© Content That Works

© 2005 Content That Works – All Rights Reserved • contact us at 866-6CONTENT or CONTENTTHATWORKS.com for licensing information.