The dangers of interest only loans
EDITOR: Please note that this author who works as a journalist in the industry, does not yet realise, the people who were encouraged to apply for these loans DID NOT KNOW they were being sold INTEREST ONLY LOANs. In some cases, as it turns out via evidence, neither did the sellers! Sellers also fell victim to these loans as the banker written material provided and processes never mentioned IO. IO is a BIG BANK SCANDAL. In old language they are thirty year bridging loans wrapped up in a LOW DOC package. Sellers (brokers and ban managers were taught to go out and "make people happy." No-one is left happy and most end up within five years losing the investment unit AND their own homes! ITS A BANKER SCAM.
Nila Sweeney
http://www.yourmortgage.com.au/article/the-dangers-of-interest-only-loans-83319.aspx
An interest only loan can seem like a great idea at the time – but there are plenty of risks involved in buying a property with a loan that fails to pay off any principal.
Interest only loans are popular with property investors, as they allow you to minimise your mortgage repayments in the short-term, while your property asset hopefully grows in value in the long term.
Interest only mortgages are exactly what they sound like: they require the borrower to repay only the interest on the loan, rather than a standard principal and interest loan.
Let’s say you own a property worth $360,000, with a $300,000 interest only loan at 7%. Your monthly repayments would be just $404 per week
On the other hand, with a standard principal and interest (P & I) loan, the weekly repayment would shoot up to $534.
Clearly, the immediate cost savings are significant, and they can help to ease the financial pressure in the short term - but it comes at a price.
The main disadvantage is that you’re making no headway on your overall mortgage.
In the above scenario after five years have passed, you’ll still owe $300,000 on the property if you take out an interest only loan.
With a standard P & I mortgage, after five years you would have shaved a good $50,000 off the balance of your home loan.
Essentially, this means that you will not have the benefit of gaining equity in your home, even though you are making mortgage payments every month.
Investors work around this by predicting that in five years time, the value of the property will have increased anyway.
They hope that their $360,000 property will be worth at least $400,000, so they will have equity in the property without having paid a single cent off the principal.
(You can use a mortgage calculator to work out your interest repayments)
But what if the property doesn’t increase in value? Just ask Darren Vistas, a sound engineer from Queensland who bet on an interest only loan – and lost.
“I bought an apartment in a regional coastal city in 2006, for $155,000,” he says.
“I thought it was a total bargain! I paid a 20% deposit and got an interest only loan for the rest ($124,000). My goal was the hold the property for five years and then sell, so I could use the profits to buy my own home.”
Unfortunately, property prices didn't increase in the five years since Darren invested in his two-bedroom apartment.
“I was going to hold onto it in the hopes that values would pick up in the area eventually, but I couldn't see things changing any time soon, and the bank wouldn’t lend me any money for my own home with this investment debt hanging over my head,” he says.
“It’s a learning curve – a very expensive learning curve!” he says. "I definitely won’t be getting an interest only on my next purchase, that’s for sure.”