If I could offer you a larger mortgage and a lower monthly payment and promised you wouldn't have to start paying it off for as long as 10 years, would you be tempted to sign up?
A number of the big mortgage companies, such as Washington Mutual
The concept is fairly simple. For a minimum of three years, and up to 10, a borrower only has to pay interest on the mortgage, but not principal. Following the interest-only period, the mortgage reverts to a fixed-rate loan, usually of the traditional 15- or 30-year variety. Monthly payments can be up to 30% lower during the interest-only period, something every cash-strapped consumer can appreciate. Of course, if no principal payments are made, the borrower is back to square one when the interest-only period is over, facing down a full 30-year mortgage.
Since most institutions qualify borrowers based on the artificially low monthly payment, these mortgages are disingenuously billed as a way for Mr. and Mrs. Average Homebuyer to get that bigger house they really want. Nobody cares that homeowners are likely to be maxed out just on the interest payments, with little capacity for future principal payments. It's all about the here and now, and they can afford it now.
Not that there aren't advantages to interest-only mortgages. Most are written to allow for principal repayment during the initial period, making it a great tool for people with "lumpy" incomes, such as sales professionals, who can take advantage of the good times to pay principal and fall back on the interest-only payment during lean times.
Interest-only mortgages are great tools for just about everyone except the market they're being aggressively targeted to: the average homebuyer. Already burdened with historically high debt levels, average Americans are taking advantage of non-traditional mortgages to borrow even more. And while the borrower is ultimately responsible for the decision, marketing of interest-only mortgages to those who can ill afford them is not the most honest practice.
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Fool contributor Chris Mallon is quite happy with his fixed-rate 30-year mortgage and doesn't own shares in any of the companies listed.