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Ask Dr. Don

Ask Dr. Don

Interest-only loans

Hello Dr. Don,
Here is our dilemma: We have $25,000 to put down on a $335,000 house. Our lender is trying to talk us into an interest-only loan, and we are not familiar with this loan type. Would this be a good loan to get or is there some other type of loan that would best suit our needs?

We also would like to know if it is a good idea to use the profits from the sale of our current house to pay down the new home loan, or to upgrade the new home with some additions. The new house will be purchased prior to the sale of our current house so we can't use the home's equity for a down payment on the new house.
Permanent Principal

Dear Permanent,
Loan payments have two components, principal and interest. An interest-only loan has no principal component. The $315,000 loan balance would remain outstanding until you replaced it with conventional financing, or the note is paid off.

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With an interest-only loan, any equity you have in the home comes from either the down payment or the home's price appreciation. An interest-only loan will have a higher interest rate than conventional financing with the same term because of the increased risk to the lender. The interest expense doesn't decline over time, so the mortgage interest deduction should stay stable over the life of the interest-only mortgage. It's not going to be easy to find a lender willing to loan you money for longer than 10 years on an interest-only basis.

There are times when a bridge loan makes sense. A bridge loan is an interest-only loan that finances the new home until the old home is sold. A bridge loan typically is written for a six-month term but may have renewal provisions. I'm not a big fan of bridge loans when that means that the homeowner has two mortgages to pay. I'd only borrow using a bridge loan if I were very confident that my current home would sell quickly.

Mortgage loans where the borrower has almost no equity in the home are riskier and carry higher interest rates. Lenders will require private mortgage insurance when the loan-to-value is greater than 80 percent. After the current residence sells, you may be able to pay down the note to where PMI no longer is required. Unfortunately, that may mean that you don't have the money to purchase the upgrades and additions you want. But -- you can always take out a second mortgage to pay for the work. The trade-off is the higher interest expense with the second mortgage vs. the PMI payments with the first mortgage. When the house sells, your lender should be able to help you make that decision. Or you can write back to Dr. Don.

Sears card rates

Dear Dr. Don,
We have a Sears Premier card with an interest rate of 21.99 percent. In its weekly flyers, Sears advertises a rate of 14.99 percent to 25.99 percent for this same card. I've called customer service several times and I've been told that anything lower than 21.99 percent is a promotional rate. I've sent a letter to them with enclosures of the flyers showing that it's not a promotional rate but never get a response. How can I get a rate of 14.99 percent on my Sears card?
Notta Promo

Dear Notta,
I pulled the Sears flyer out of the Sunday paper, and saw the same 14.99 percent to 25.99 percent that you referred to in your letter. So I sent Sears an e-mail asking them how they determine what interest rate a customer will pay on a Sears Card. Sears replied that it uses credit reports, demographic data and an overall credit score to determine credit risk and the subsequent rate to a borrower.

The good doctor prescribes two bromides to cure your indigestion over this matter. First, trust the company to know its business. If it tells you that you aren't eligible for a 14.99 percent card, then you aren't eligible. Second, if you don't like paying 22 percent interest on your purchases, either pay cash or vote with your feet and shop where you can get a better interest rate.

If you're using your Sears card to build a credit history, then pay your bills on time and be careful not to run up large balances. Working your way out of a hole you dug with a 22-percent shovel won't be fun.

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Bankrate.com writers base their answers on our editorial content and advice of financial professionals. We make no claims or representations about the accuracy, timeliness or completeness of such content, advice or the answers provided to you. Our content, advice and answers are intended only to assist you with your financial decisions. However, by its nature such information is broad in scope. Your financial situation is unique, and our content, advice and answers may not be appropriate for your situation. Accordingly, we recommend that you get different opinions and seek the advice of your accountant and other financial advisers before making any final decisions or implementing any financial or investment strategy.

-- Posted: Dec. 3, 1999


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