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Ask Dr. Don
By Don Taylor, Ph.D., CFA • Bankrate.com
 Dear
Dr. Don,
Is it possible to get a fixed-rate loan on my primary residence
without ever paying down principal but only paying interest every
month? I am assuming that the interest would be tax-deductible.
Max Deduction
Dear Max,
You are looking for a bullet loan, or a loan with a balloon payment.
With this type of loan, your mortgage interest deduction never goes
down, because your loan balance never goes down. You may even be
able to afford a larger house, since your monthly payment doesn't
include a principal component.
However, when lenders commit to such loans,
they are making an investment. Investors want two things when they
invest, the eventual repayment of principal and a return on their
investment. A bullet loan is riskier to the investor because the
homeowner's equity in the property doesn't increase with the passage
of time. The lender faces a higher default risk with this type of
loan. And remember that higher risk means higher rates. Without
an established relationship with a lending institution, it will
be very difficult to get a fixed-rate bullet loan for longer than
seven to 10 years. I am assuming that you would structure the loan
to avoid paying private mortgage insurance (PMI) by putting 20 percent
down or by arranging a second mortgage on the property, and that
your down payment is the same regardless of the type of mortgage
you choose.
Let's assume you borrow $150,000 at 8 percent
in a conventional 30-year fixed-rate mortgage. After 10 years, you've
paid down about $18,500, leaving a $131,500 loan balance. The reduced
interest expense associated with the principal payments causes you
to pay about $500 more in taxes in year 10, and $2,300 total during
the first 10 years (using a 36 percent federal tax rate). But that
assumes that you get a bullet loan at the same rate as a fixed-rate
mortgage. If it costs you a half-percent more or 8.5 percent for
the bullet loan, the bullet loan actually costs you $8,900 more
in interest expense, after-tax, in the first 10 years.
Your monthly payment is about $40 less with
the 8.5 percent bullet loan vs. the 30-year fixed payment. Earn
12 percent annually in a mutual fund on the $40 per month and after
10 years you end up with a fund worth about $9,400. Cash out, pay
Uncle Sam $920 in capital gains taxes, and use that money to pay
down your loan. You've got an outstanding loan balance of $141,520.
Doesn't make sense to me.
If you still think this is the way to go, talk
to your commercial bank and see what they can do for you, since
you can't shop for bullet loans on this site, or any of the other
sites I tried.
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
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Your financial situation is unique, and our content, advice and
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we recommend that you get different opinions and seek the advice
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final decisions or implementing any financial or investment strategy.
-- Posted: Aug. 20, 1999
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