Once a symbol of pre-crisis lending, interest-only mortgages are making a comeback—offering new opportunities for lenders but also raising familiar concerns.
The product, which allows borrowers to pay interest first and then principal, is increasingly inquired about both by borrowers and investors looking to buy houses, mortgage lenders that specialize in non-QM products say.
The benefit of an interest-only loan is that a consumer’s payments remain low for a set period of time, usually 10 years while they’re paying off interest, but after that, payments do significantly grow, some warn.
Interest-only loans can be a boon for those that have seasonal income with a big bonus at the end of the year, or for professionals, like doctors, who might be paying off school loans for a short period of time. It is also a timely product for investors, or borrowers who are confident that rates will drop at the end of their interest-only term, opening up the door for a refinance, stakeholders interviewed said.
Stats provided by MeridianLink, a software company, show that demand for the product has steadily increased.
“MeridianLink’s nine-year average on interest-only first lien mortgages (including home equity line of credit loans) is 1.6%. Interest-only first lien mortgages are currently at 3% of total volume, or about double the average demand over the past nine years,” a company spokesman shared.
Before 2008, interest-only loans were widely popular because borrowers could qualify based solely on the lower initial payments. However, this approach often led to buyers taking on homes beyond their means, ultimately contributing to widespread foreclosures.
Nowadays, the qualifications for the product have been changed. Borrowers applying for an interest-only mortgage are qualifying off of the fully amortized payment for the term of the loan, said Tom Davis, chief sales officer at Deephaven Mortgage.Davis has seen this product gain popularity with borrowers who want to be short-term homeowners, or investors.
“The initial payments are usually lower than a fully amortized loan so it can help you to afford a home that potentially is going to be a little bit pricier and it also helps with allowing an investor to have better cash flow,” the Deephaven executive said.
Investors applying for an interest-only loan typically go through a different qualification process, where they only have to qualify based on the interest only payment.
But with the positives, comes the reality that this product may not be the right fit for everyone.
It is a product that should be considered with caution, noted Michael Pearson, senior vice president of business development at non-QM shop A&D Mortgage.
“What you don’t want to see happen is for [a borrower] to get at the end of that interest-only period, their mortgage payment is going significantly higher, and they haven’t actualized that income, and now they’re in trouble,” the A&D Mortgage executive said.
For borrowers opting for this loan “it takes discipline,” Pearson added.JP Kelly, senior vice president of mortgage at MeridianLink, echoed those sentiments, noting that while this may be a good tool while interest rates are elevated and there’s a lack of inventory, a borrower needs to be mindful of where they’ll be financially when the interest-only period expires.
“When that introductory period ends, borrowers could end up having sticker shock, very similar to what some people have with adjustable rate mortgages. That’s why it really has to be for the right kind of borrower at the time,” he added.
