Are Interest-Only Mortgages Right for You? You Might Be Surprised.

Interest-only rate mortgages might be especially tempting if you need to get out of debt, have cash flow problems and/or need to generate more income during retirement.

But are they really the best choice?

Not if you plan on owning your home for more than seven years and have stable employment or income.

Let’s look at an example.  A friend of mine has an outstanding balance of over $700,000 on his mortgage.  He came to me with a question, “Should I refinance my mortgage?” Let’s see.

He currently has a five-year interest-only loan and makes a monthly payment of $2,400. He told me that he can refinance now and get a fixed 30-year mortgage. If he does so, his payments will go up to $3,600 a month. He told me that he lives in his dream house and hopes to stay in his current home for as long as he lives. He was thinking of holding on to his current interest-only loan, keep his expenses low and then refinance in five years.  His plan is to keep his expenses low for as long as possible and live off of his retirement investments in about 10 years.

I told him he was out of his mind and he had to jump on that 30-year fixed.  He couldn’t understand why I felt so strongly.  Here’s what I told him:

If rates go up in 5 years to 7%, his annual payments will be 7% of $700,000. That’s $49,000 a year.  And that’s over $4,000 a month.  So the choice my friend has is to lock in a payment of $3,600 a month now or take his chances on what the rate will be in five years.

With mortgage rates basically at all-time lows, does it make sense to take the chance that these low rates are going to be around five years from now? Absolutely not.

What say you? If you were in my buddy’s situation, what would you do?  Do you agree that my friend is loony for not jumping on these low rates?

photo. All-Seeing angler