Here's the pitch: You're an upwardly mobile, financially savvy borrower managing your own investments. Interest rates are at historic lows, home values continue to magically rise, and you do not plan to be living in the same house in five years. What about taking out an interest-only loan?
With the lower monthly payments, you could buy a bigger house, and in a few years, when you're ready to refinance or trade up, you won't be in any worse shape for equity than you would have been if you had taken out a 30-year fixed-rate loan.
Across America, more lenders say they have struck a gold mine with interest-only loans. This niche has been a mainstay for thrifts since the 1980s. In the late 1990s Wall Street, seeing an opportunity to profit from one of the few remaining mortgage sectors not dominated by the government-sponsored enterprises Fannie Mae and Freddie Mac, expanded lenders' access to the loans.
Now national banking companies like J.P. Morgan Chase & Co. of New York are getting into the act. Citing consumer demand, Morgan Chase in January introduced three interest-only 30-year products with adjustable rates, as well as a "fixed" one.
"This is a very important product. In markets such as this, consumers want to take advantage of current low interest rates, and as rates increase the (low teaser rate) gives them more protection," said Tom Garvey, an executive vice president in charge of national production at Chase Manhattan Mortgage in Edison, N.J. Mr. Garvey said that Morgan Chase has gotten $250 million of interest-only loan applications in the past few weeks, and he expects the business line to provide solid growth in the future.
The "fixed" interest-only loan allows the borrower to pay as little or as much principal as desired over the 30-year term. Morgan Chase prices the loan at its prime rate, which is currently 4.25%, more than a percentage point lower than that for competing conventional fixed-rate loans. The loan's rate adjusts with the prime rate every six months. Morgan Chase still offers a 40-year version of this product but says the 30-year one will find more takers. Its adjustable-rate loans have initial interest-only periods for five, seven, or 10 years, after which the rate adjusts annually and the loan begins to amortize.
More typical interest-only adjustable-rate loans, such as those made by HomeBanc Mortgage Corp. of Atlanta, are indexed to the London interbank offered rate. Many consumers prefer this setup, because it is less volatile than other indexes.
Patrick S. Flood, HomeBanc's chief executive officer, said that it started originating interest-only ARMs in the mid-1990s. At first they represented only 10% of his business, because many borrowers were not comfortable with having their rates change several times a year and loan officers were not familiar enough with the product to make a persuasive pitch.
HomeBanc held seminars for its employees and spent some extra time on the phone talking to borrowers about the loans. In the last two years interest-only ARMs have increased to about 40% of its annual originations. For mortgage bankers, the primary attraction of these loans is that Wall Street firms, such as Bear, Stearns & Co., have bid for them aggressively, Flood said. (Bear did not return calls seeking comment.) And for investors, he and others said that, surprisingly, they would expect an interest-only loan to stay on the books longer than the average fixed-rate one.
"It's an incredibly efficient way to borrow, and over time these will prove to be less prepayment-oriented than fixed-rate conventional loans," Flood said.
Because the loans' rates can rise, "it would appear that the payoff could happen faster, but that's not what we're experiencing," he said. "These loans work well because they move with the marketplace. Customers don't refi them as much as they do fixed. They hang in there, because they think rates will go down again." And with initial rates in the 3% range, interest-only borrowers save a lot early on, and that can help them to make increased payments when rates rise, he said.
Garvey said that even though Chase does not have much experience with the loans, it is holding them in its portfolio, because it believes they will be prepaid more slowly than conventional loans.
Steven Schnall, the president of New York Mortgage Co. LLC, said that, with interest rates so low and with so many willing buyers in the secondary market, interest-only loans are a cash cow at the moment. "They are becoming much more widely available. In the last handful of years, a couple of major national conduits have begun to offer them, and now they're widely accepted," Schnall said.
So widely accepted that the GSEs might want a bigger share of the business? According to Fannie's Web site, it buys a product called Interest-First that is interest-only for the first 15 years and then begins to amortize over the next 15. It is available as a fixed-rate loan or as a hybrid ARM. However, "they haven't made the pricing work yet," according to Flood.
"Over time customers will begin to become more interested in it, and the market," including Fannie, "will accommodate them."
In other words, until more consumers start to clamor for the product, the GSEs will probably play a small role in this growing niche.
