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Thursday, August 31, 2006
Roger Schlesinger :: Townhall.com Columnist
On the Wall Street hit list - Interest only loans
by Roger Schlesinger
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Why is Wall Street so interested in the real estate market? They seem to have an opinion on every aspect, whether they understand it or not, letting nothing stand in their way. I hear interviewers talk about how real estate is falling off a cliff, the bubble is bursting, sales are down further than anticipated, inventory is up higher now than in years and many houses are vacant. These are just some of the comments that come out on a daily basis. I am neither interested in challenging these thoughts or concurring with them, because they are not integral to my thesis. But I bring them up to show the Wall Street bias to real estate. Apparently, real estate is perceived as serious competition to investment in the stock and bond markets.

I will mention that although the comments keep coming, real estate nationwide is still showing gains, not losses. Also, the biggest markets like San Diego, California are showing some downturns, but only around 1%. If value remains in a market where there is little demand and excessive supply, what is going to happen when demand returns?

I really wish to concentrate on interest only loans, which leads a list of little respected vehicles available to real estate owners. I wish to compare and contrast many aspects of the interest only loan to other phenomena we have in our society.

As an example, according to Wall Street, the interest only loan isn't smart or safe, but leasing a vehicle is fine.

When you realize you are only paying for the utility of the vehicle and not the vehicle itself, you have to wonder how this compares to the interest only loan. Vehicles predominately lose value, and houses generally gain value. Without getting into the nuances of the auto lease vs. interest only mortgage loans, I believe there is greater reward in interest only loans than there is in auto leasing, yet auto leasing is not on the "financially dangerous" list and interest only loans are.

The Wall Street crowd will sell you a "growth stock", one without a dividend, and tell you the reward is in the growth of the company and the increase in the share price as a result of the growth. Why isn't an interest only loan a "growth loan" with the payoff coming with the increase in value of the house and the low, tax-deductible expenditure on the loan? They fail to mention it!

Now let's look at the interest only loan and compare it to a fully amortize loan, preferably the 30-year fixed. The 30-year loan will amortize about 12% in the first 10 years. On a $300,000 loan at 6%, you will have a balance of approximately $260,000 after the first decade of the loan. If you were to take an interest only loan at the same balance and rate, you would save $36,000 in actual payments, or almost the same as what was amortized. If you invest your savings stream you might be way ahead of the game. Continued...
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About The Author

Roger Schlesinger's Mortgage Minute is heard on hundreds of radio stations and daily on the Hugh Hewitt radio show and Michael Medved shows. Roger interacts with his hosts and explores the complicated financial markets in order to enlighten his listeners and direct them along their own unique road to financial freedom.

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(6 comments so Far)
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Reply # 1
Date: Sep 5, 2006 - 1:38 PM EST
New loan products- IO and others
Wall street is interested in the RE market because they know what a large effect it has on consumption and our consumer based economy. They know about money and credit, and what it does to people.

First of all I'd like to challenge some of the editorials assumptions, in real terms (that is adjusting for inflation) and the long run, RE doesn't go up in value, it just keeps pace. A house produces nothing other than the utility of not paying rent. A business produces a product. The big advantage for most people is that a house is basically a forced savings account. Of course with IO, there are no "savings" per se.

Also, leasing a car is finacially stupid for most people. For most people, its a way of front loading gratificaiton at the expense of the future. The people that it might make sense for are people that can write off the lease payments against income for a business, and people that are silly enough to want to continusously "own" a car during its highest depreciating period. People don't make such a stink about leasing cars vs money for RE because you're less likely to be ruined by a car. They're both generally not good choices, a car is just a smaller sin.

Most of the people getting these loans aren't high payed commision based people, they're people that know little about money and credit and think in terms of monthly payment instead of total cost. They are people that saw this type of loan as the only way to get a toe hold into the speculative market. So in edition to being teachers and bakers, these people are now real estate speculators. These types of loans add risk to markets that lay people are coerced (by tax policy) to participate in.

Also, these types of loans aren't new. In fact they're very old. The last time they made a big splash was in the credit expansion (AKA the roaring 20's) that lead to the a little ditty known as Americas Great Depression. After that little event, IOs were largely abandoned as being too risky in favor of the convention fully amortized loans until just recently. Everything old is new again.

So I'm glad mortgage brokers have made a lot of money selling these types of products, maybe they'll be able to use some of the proceeds to defend themselves when they start getting sued (wronly or not) by people getting booted out of their homes.

Don't get me wrong, I think people should be able enter into any kind of lending arrangement they want, but don't tax me to bail out a once again failing bank system when many of these loans go belly up all at once.

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Reply # 2
Date: Sep 1, 2006 - 9:04 PM EST
payment of interest only
I was emailing Roger Schlesinger as to why if the fix mortage is paying the interest up front why the payment on interest only would be less. Click. Because the interest of a fix is in reality paid off in about 15 years. Taking the interest that would have been paid 30 years from now and putting it on the front of the mortage. Meaning the interest payment in the beginning of the mortage is higher then what the average interest would be. Interest only takes away the double interest payment and also takes away the prinicipal payment making the payment far lower. So, you get to invest not just the principal part of the payment that you didn't make but also that second interest payment that the fix forces you to pay 30 years ahead. That is 30 years of wealth acumulation you get on that interest payment.
That right there makes interest only mortages better then fixed. If you have the ability to save. Or take the double interest side of the payment and use it to pay down the loan. Your monthly payments will drop as the balance of the mortage drops. That way technically it is still an interest only loan vs a fixed mortage and you still get to keep the principal payment to invest or pay down the mortage.
Thanks Roger, never had really put thought into the interest only mortages other then...wow..I will never pay off my debt:)
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