Seattle Times Pumps Interest Only Loans

From the Seattle Times over the weekend:

Almost every dollar Todd Asher earns is spoken for. He has one daughter in college, another in high school and a toddler in diapers.

“We made a decision to have my wife stay at home with our 18-month-old son, so we’re living off my income, paying for tuition, diapers and everything else,” said Asher, of Sammamish. “We’re all about making money go as far as possible.” Asher, 39, has found a way to save a little each month through an interest-only mortgage loan. He diligently puts the savings into his 401(k), an individual retirement account and mutual funds.

“My goal when we purchased our current home was to buy the most house for the least amount of money and then save, save, save,” Asher said.

Does this logic sound a bit off to anyone? What happened to the idea of living below your means?

Some mortgage specialists and financial planners believe unconventional home loans could be good tools to help consumers put away money for their future — if they’re disciplined enough to invest the mortgage savings.

If homebuyers invest the extra $160 to $200 they save each month on an interest-only mortgage, then it “absolutely makes sense,” said Jeff Tisdale, a broker at Skye Mortgage in Bellevue.

Totally, Jeff.

But Paul Merriman, founder and president of Seattle-based Merriman Capital Management, said every dollar a young homeowner invests now from mortgage savings will make a surprising difference when he or she retires.

Consider this scenario: A 30-year-old homebuyer invests $200 a month in a Roth IRA for five years. With a 10 percent compound rate of return (based on the S&P 500), he will have $15,312 in five years. Then, because he faces a higher mortgage payment of principal and interest, he stops contributing to the IRA. Even if he adds nothing more to the investment, the money continues to multiply.

“They will have $267,185 at age 65 and they will be able to take tax-free distributions of $16,031 (6 percent) the first year,” Merriman said. “If they continue to earn 10 percent while taking out 6 percent, they will take out over $500,000 and have $585,435 left at age 85.”

Consider this scenario: Based on the last 35 years of inflation, $267,185 will only be approximately $53,034 in 2042 dollars, which probably won’t even buy you a Hyundai (assuming there are any fossil fuels left in which to operate it)

I think it’s also safe to consider that whatever McMansion they purchased will be worth much, much less than their purchase price in years to come. Money isn’t free and without exception debt -always- must be repaid. How will this paycheck-to-paycheck family ever get out from under this house?

“Most people want everything now, and they come back every two years looking for more money,” he said.

He also has families who “come back a little richer” each time with more money in the bank.

“I can’t keep track of what people do once they walk out my door,” Tisdale said. “I can tell you that the ones who are committed to investing their savings are rare.”

The home ATM has all but dried up. The American public is now in their 19th consecutive month of negative savings. This family and many like it are are literally living on borrowed time. What’s the point of an interest only loan when you can rent a suitable home, closer to work, for much less than “buying”. Why put yourself under such pressure, especially when you aren’t building any equity?

A house has become more of a consumer product than an investment, especially based on current false valuations and the way they are physically built today.

This family is only one job loss, sickness, or interest rate hike away from a CH13 bankruptcy. The American Dream is looking more and more like a nightmare. The suburbs with their large McMansions will be the slums of the future.

(Linda Thomas, Seattle Times, 12.16.2006)

  

16 comments:

  1. 1
    wreckingbull says:

    Like sailors on shore-leave.

    As I have said in the past, we will all pay for this soon in a GSE bailout that will make the S&L crisis seem like a tea party.

    I read this week that 2/3 of U.S. families live paycheck-to-paycheck. Excluding those families struggling with poverty, I find that statistic downright disgusting.

    Rate this comment: Thumb up 0

  2. 2
    E-sidedave says:

    At least this family only has 1 working spouse. I think things would be much worse if they were both working. At least this way, if things really get bad, the wife can go to work. They are in a much better position than the families who are strapped, but with both spouses working.

    Rate this comment: Thumb up 0

  3. 3
    Slinky says:

    “Some mortgage specialists and financial planners believe unconventional home loans could be good tools to help consumers put away money for their future — if they’re disciplined enough to invest the mortgage savings.”

    Bwa-HUH?

    Did I miss something there?

    If you pay that extra $200 or so toward your PRINCIPLE, then in the long run you will pay much, much, much less money than if you only pay the interest! There is no way that investing in the market (or even saving at 3% interest per annum) can come close to the amount of extra money these folks will pay because they have that I/O loan.

    When I was looking at buying, somebody offered me a $130k loan with a five-year I/O feature. Compared to a 30-year fixed for the same amount, I would pay something in the ballpark of $150,000 more on the house because of the I/O feature. I almost hung up on the lending agent who told me there was no catch to I/O loans…I managed to be polite but it was a near thing.

    That advice to “save money” by using an I/O feature is possibly the worst bit of financial management advice I’ve ever heard. Ever. That’s just awful. Did the fishwrap editors even read that bit of drivel? Did they stop and think about whether what they were writing made sense, or did they just blindly parrot an industry shill?

    Rate this comment: Thumb up 0

  4. 4
    Richard says:

    “The home ATM has all but dried up.”

    I think we’ve got a way to go before we can say the home ATM has dried up.

    REFINANCE ACTIVITY REMAINS HIGH; CASH-OUT SHARE INCREASES IN THIRD QUARTER

    It’s nowhere near over. As more people are faced with refinancing their ARMS in 2007, it’s safe to assume alot of these people are going to pull out equity with which to make their higher payments.

    Rate this comment: Thumb up 0

  5. 5
    Slinky says:

    Richard, ouch.

    If you have to take a loan to make payments on the loan, it’s time to cut your losses and SELL.

    Rate this comment: Thumb up 0

  6. 6
    Richard says:

    Slinky, the way I see it, it’s the same as rolling consumer debt into a mortgage – which is already the status quo.

    If you were determined to keep your house and you had the option of a) reducing the loan amount but not being able to afford the payments or b) increasing the loan amount and having an extra $30K to dip into to afford the payments, which makes more sense?

    Rate this comment: Thumb up 0

  7. 7
    john_law_the_II says:

    my grandparents on both sides never did risky stuff like this and they both came out relatively well by saving money and owning their own homes.

    why do people need to take such risks?

    Rate this comment: Thumb up 0

  8. 8
    MisterBubble says:

    “why do people need to take such risks?”

    Because otherwise, they can’t “afford” homes at current valuations.

    Rate this comment: Thumb up 0

  9. 9
    Alan says:

    If you can get a higher rate of return on your money than you are paying on your mortgage and you are comfortable with the risk that you might not get that rate of return and you are disciplined enough to actually invest the difference then an interest only mortgage probably does make sense. The fact that you are paying a lot more in interest over the life of the mortage does not matter since you are making even more on the investment.

    If I could get a guaranteed 6% rate of return in some investment, I would borrow and invest as much money as anyone would lend me at 5.5%. Unfortuntely, the fact that any rational person would do the same makes opportunities like that rather rare.

    Rate this comment: Thumb up 0

  10. 10
    synthetik says:

    >The fact that you are paying a lot more in interest over the life of the mortage does not matter since you are making even more on the investment

    That type of logic might have only made sense between 1996-2005. I think the actual inflation adjusted appreciation nationwide has been something like 1% over the last 100 years.

    These past few years have been an abberation and to suggest that valuations will continue to go up unabated is, well, ludicrous.

    How are you making more on your investment when you just lost 30 or 40% of your value by 2008? Some are predicting a Japanese-style 15 year drop in values.

    We’ve had a tremendous runup fueled by cheap oil, productivity gains and hyper low interest rates.

    It was fun while it lasted.

    Rate this comment: Thumb up 0

  11. 11
    Alan says:

    Synthetik,
    That is an argument against buying — not against interest only loans. I agree that buying at all is a mistake right now, but if you have an investment opportunity that earns more than the mortgage rate, getting a standard 30-year fixed is a bigger mistake than getting a interest-only loan and investing the difference.

    Although my argument is mostly theoretical anyway. Mortgage rates are influenced by investment opportunities in the rest of the market. It is non-trivial to find a guaranteed investment that beat the mortgage rate. The payment difference at the beginning of the mortgage (which is all payments in the interest-only case) is only around 5% of the total payment. With a $3000 mortgage you would be saving $150/month. Given that you can rent the same place for $1700/month you are obviously much better off renting and saving.

    Rate this comment: Thumb up 0

  12. 12
    Wanderer says:

    I nearly lost control of myself when I saw that 10% was presented as a guaranteed return. They can list the historical return of the S&P500 all they want but neglecting risk is ludicrous. Without going into B.S. business school calculations, you know how to prove that it is a bad idea to take on a higher interest rate in the future so you can have lower payments right now???

    Answer: Because the banks will let you do it!!!! They aren’t in business to help Americans realize the dream of owning a home. They are in business to make money with the least amount of risk possible. If they thought 10% was a lock, do you think they would be lending money at 6%… or even 9.9%???? Hell no. If the CEO’s of all the banking institutions thought it was so easy to take an extra 150$ in monthly payments and reinvest it at 10% guaranteed, they would do so in a heartbeat.

    The only thing that shocked me more than the article was finding others like it on the web. There are a lot of dangerous people out there.

    Rate this comment: Thumb up 0

  13. 13
    Slinky says:

    Synthetik wrote: “Some are predicting a Japanese-style 15 year drop in values. “

    Actually, on Nightly Business Report on PBS last night, the commentator did exactly that. Neither the Lehrer News Hour nor NBR are the type to cry wolf.

    Rate this comment: Thumb up 0

  14. 14
    Anonymous says:

    Interview with Gwen Ifill of PBS News Hour:
    DAVID LEREAH: Balloons don’t burst. You can put air in a balloon and it can expand or you can deflate a balloon, where air comes out. So if you’re looking at different metro markets around this country that got real hot over the last four years, I like to use the imagery of balloons because they’re getting hot. You’re putting more air into those balloons. The prices are going up. But now air can come out of the balloon rather than the balloon popping.
    GWEN IFILL: So we’re hearing a hissing sound rather than a pop

    His analogy of a baloon not popping only works if you don’t put too much air in them. Obviously Mr. Lereah hasn’t blown up a balloon to the point of it bursting, which Interest only loans have allowed us to do.
    Using my house as an ATM allowed me to put my daughter through college, which is a good thing and I was able to get outta So Cal just in the nick of time. I don’t think a lot of people are so lucky. I don’t hear the hissing sound of air being released slowly, I am covering my ears for the “Pop” of the balloon bursting.

    Rate this comment: Thumb up 0

  15. 15
    patriotz says:

    It is non-trivial to find a guaranteed investment that beat the mortgage rate.

    “Non-trival”? It’s impossible.

    The return to the mortgage lender isn’t guaranteed, so it has to be higher than any guaranteed investment.

    Get a brain, man.

    Rate this comment: Thumb up 0

  16. 16
    Wendell says:

    “I read this week that 2/3 of U.S. families live paycheck-to-paycheck. Excluding those families struggling with poverty, I find that statistic downright disgusting”.

    This has nothing to do with the bubble.

    Rate this comment: Thumb up 0

Leave a Reply

Use your email address to sign up with Gravatar for a custom avatar.
Your email address will not be published.

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

Please read the rules before posting a comment.