Dear Dr. Don,
We want to buy a condo but can’t afford a 30-year fixed-rate mortgage. We were thinking about a five-year interest-only loan, which we later plan to refinance.
How much is the annual mortgage interest deduction going to be with a $75,000 salary? Do you think we will gain or lose in five years? If we just sell or refinance does it make a difference?
I’m told that the five-year interest-only payment is $864, while the five-year principal plus interest payment is $1,151. We’re looking at a $260,000 mortgage after making a 10 percent down payment.
— Dee Double-Down
One feature of the recent financial crisis was that people bought homes they couldn’t afford. Interest-only loans were involved. There were many parties to blame. But in your case, the decision to opt for an interest-only mortgage is a sign to me that you might want to buy a house that you really cannot afford. At minimum, it is a risk.
Try Bankrate’s “How Much House Can I Afford?” calculator. I don’t know about your other expenses. But if you need an interest-only loan to afford the mortgage payment, you might be getting in too deep.
No one can honestly tell you what home prices will be five years from now. We can only guess. There are too many variables. So much depends on the location and condition of the property compared with competing properties on the market.
Planning on being in the position where you have to sell to get out from under the mortgage is an expensive and risky strategy. You’ll pay real estate commissions on the sale, moving costs and closing costs if you buy a new house. For example, think about the prospect of a 10 percent decline in the appraised value of the condo. It would leave you with no equity while you are making only interest payments on the loan.
If you refinance, remember you’ll pay closing costs on the new loan. You’ll also have to qualify for that new mortgage. The amount of equity you possess and the level of interest rates will go into the mix at that time. We don’t know how high interest rates will be, but most experts believe they’ll be rising in the coming years.
I used Bankrate’s “ARM or fixed-rate mortgage” calculator for you. For this to work, the five-year interest-only adjustable-rate mortgage has a rate of about 3.99 percent. The fully amortized 5/1 ARM has a rate of about 3.39 percent.
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