In 2001, 1.4% of California homes were bought using interest-only adjustable rate mortgages. In 2004, that number was a staggering 47.8%. Such mortgages are highly risky because after a predetermined number of years, usually between 3-7, you must start to pay off the principal too. This means a higher monthly payment. Plus, the interest rate is variable, and given the current climate, the rate will almost certainly be higher than the original rate, and that means a even bigger mortgage payment.
People use such risky loans because they can’t afford traditional fixed loans. So, a probable increase of several hundred dollars a month in their mortgage payments once the principal payment kicks in means many will not be able to pay. If that happens, they walk away from the house, and if it is worth less than what they paid for it, they could be liable for the difference. Given the new much tougher bankruptcy laws, they may not be able to do a bk either.
How crazed is it?
Two examples from the article
Miseon and T.G. Kang just sold their town house in San Jose for $625,000 and bought a new home for $1.21 million.
“We paid a premium. We wanted this house. Without an interest-only loan, we couldn’t have afforded it,” said Miseon Kang, a pharmacist. “For five years, our payments will be OK. But after that, they’ll be a problem. My husband and I are concerned.”
Last fall, Herron decided to take the plunge. With the first four places she found, she was outbid. Then a bottom unit in a fourplex became available, and she got it. She’s still amazed.
“I have $40,000 in student loans from my master’s degree,” Herron said. “I have high credit card debt. I’m a typical American. And yet they wanted to give me more debt to buy a house.”
This is a bubble, it can’t last, it won’t last.