Every so often, I get questions from readers. I’d love to get more (contact me) but sometimes the questions I do get deal with topics that are a little outside my level of expertise. When this happens, I often try to direct the person to place that I think can help them find an answer. It may be a specific blogger that I know writes about the topic fairly often. However, it might be some very helpful forums. I’ve been spending some time on Wesabe Groups and find that there’s a nice community there. While I haven’t spent much time there, I’ve also read a lot about the Get Rich Slowly Forums. These are two places where you can ask questions and get a variety of answers – surely some good and others bad. As always, you’ll have to be your own judge on the best path to choose.
The question that spurred this comes from “Jonathan Papelbon” (a name I’ve picked to protect the original writer’s identity):
I bought a house a year ago, and now Zillow shows that it has lost 12% in value!!! I am paying an interest-only loan for 7 years (6 years left), and I don’t know what to do. Should I start putting money toward the principal so that when I want to sell, I will be able to break even? Or should I continue to put $$ toward other debt and savings? This is not just a decision for me, my wife does not want to be stuck here for too many more years, in case we need to move into a bigger place if we start a family.
I made an attempt to answer the question, but mostly I cautioned him about the dangers of interest-only loans and using Zillow as a guide (though it works well for many properties). The other thing that I wanted to note is that extra money saved in a bank account might be better off than put towards paying off the loan. Why? Well if you use up this buffer and then run into a few bad months, lenders will have no sympathy for you. However, if you can make the regular payments and keep that buffer money for a future rainy day, the lender won’t know it’s raining for you.
This is kind of an open question and I’m sure if we had full information someone could really give great advice. However, perhaps you’ve found something here that I missed. I’ll be the first to admit that I don’t follow interest only loans because I’ve always avoided them. If you have some good ideas please let them in the comments.
Erica Douglass says
Hi Lazy Man,
What I would recommend for “Jonathan” is calculating how much his house payment will be once the 7-year period expires, and making sure he can pay the full amount every month. That’s the first step, because what he does now is dependent on that.
If he CAN make the adjusted payment (including principal) and doesn’t intend to sell his house, he should go ahead and keep the house — and consider refinancing now while rates are low.
If he CAN’T make the adjusted payment, he should go ahead and sell the house now, arranging a short sale if necessary. He should consider renting cheaply for a few years in order to build up a cash cushion to go back into the housing market. (There’s nothing wrong with renting!)
Long-term, for him, I would recommend reconsidering buying another house. This was the statement that alarmed me most: “…my wife does not want to be stuck here for too many more years…”
If your wife considers living in a house you bought “stuck”, why would you buy it in the first place? If you aren’t planning to live in a house at least 7-8 years, they’re typically not a good investment. Again, there’s nothing wrong with renting (sometimes for years!) until you can save enough for the house you really want.
Mr. ToughMoneyLove says
To properly answer this reader’s question, we would need to know where this reader lives so we can assess the likelihood of a rebound in real estate values. Also, the question doesn’t say if the reader is already upside down on loan to value. With an interest only loan and a concern about being “stuck”, they should sell as soon as possible and rent until they can fund a purchase with substantial equity going in.
it seems like people got wrapped up into these types of loans because there was a certain amount of success in them PRIOR to the market instability. during the housing bubble run-up there were so many cases in my area where people bought 120k house using interest only loans and sold them at the top of the market for 300k while only paying 600 bucks a month. paying 30k in interest over the course of 4 years and then selling for 300k – not a bad deal. it seems like people basically got into the game at the top and fell from there.
the loan product itself is not flawed. i would have loved to be one of those people that made in upwards of 200k at the cost of 30k *at the time*
buying a house a year ago with this loan product – the couple of comments that lead things off are very good. it seems like the longer Johnathan goes down this road, the more that “stuck” feeling is going to set it. good luck Johnathan and great advice Erica and TML.
See My Money says
From what I have learned, interest only loans were designed for wealthier homebuyers. While they could afford to finance a home in the traditional ways, this instrument allowed them to put more of their money in higher yielding investments. However, sense this also provides a low entry level monthly payment, it proved a useful tool for getting people into a home when they otherwise couldn’t. If prices continued to climb, they could sell or refinance with a gain. But if you get “stuck” in a home and can’t afford the skyrocketing payments at the end of the interest only period, bad things happen.
It sounds like Jonathan is in a bad situation and needs to get serious about his debts right now. Jonathan and his wife need to face the reality that moving any time soon is probably not in the cards.
In his case I would recommend the Dave Ramsey method of having a $1000 emergency fund, and putting the rest of his money towards debt. I think it would be a very good idea to start paying down some of the principal, however if the other debts Jonathan mentions are credit cards or car loans with higher interest rates than the mortgage, he should consider paying those instead. If the other debts are student loans I would pay toward the mortgage first. Work towards getting 20% equity in your home. If you already have that I would say, pay off your other debts, then build a 6 month emergency fund.
The only good news is Jonathan has 6 more years before principal payments kick in. Depending on his housing area, there is a good chance his home price may recover by then.