Once considered the riskiest type of loan available, interest-only mortgages are making a comeback in the housing market. This time around they may not be as risky and definitely will not be as widely available.
After contributing to the housing bubble and causing it to burst, interest-only loans disappeared from the mortgage market after 2007. These loans allow borrowers to pay only the interest due for the first 10 years, after which they must finally start repaying the principal of the mortgage as well. Many lenders used these loans to help homebuyers qualify for homes they really couldn’t afford. When the interest rates started adjusting on these loans, most buyers were completely unable to make the new payments and widespread foreclosure was the result.
Now the second-largest home loan lender (through brokers) Michigan-based United Wholesale Mortgage has announced plans to offer interest-only loans again. They promise that the same dangers will not be in play this time.
"We expect the program to be an incredibly popular option for well-informed borrowers, and in turn, a significant boom for mortgage originators," said United Wholesale Mortgage CEO Mat Ishbia. "The purpose of the program is not to enable a consumer to afford a larger house; it's for savvy borrowers who can regularly afford a house on a 30-year fixed mortgage, but choose the interest-only option to save additional discretionary income."
Borrower requirements will be much stricter this time around, according to UWM. Borrowers will have to have minimum FICO credit scores of 720 (the highest echelons of creditworthiness) and 20 percent down payments will be mandatory. Additionally, borrowers will have to have a 42 percent debt-to-income ratio and the loan must be underwritten at the higher, adjusted interest rates rather than at the initial low rates.
Back in the housing boom, borrowers could put no money down on these loans and only be able to afford the starter rates. They were available to all homebuyers, especially those who did not understand what the terms truly meant.
UWM uses these loans mostly with wealthier borrowers on jumbo loans, those who know how to utilize the upfront savings to their financial advantage. "I think it's opening the door back to responsible lending, giving people choices," Ishbia reiterated. "These people can afford these mortgages. They're savvy homeowners," said Ishbia. "We're giving them the choice. It is no more risk to us. We actually think it's less risk."
Still Fannie Mae and Freddie Mac believe them to be too risky to buy from lenders. Lenders making these loans must hold them on their own books or find private investors to take them. The government-backed loan corporations will not touch them. In fact, the government has called interest-only mortgages “toxic” as recently as 2013.
Even though interest-only loans are still considered dangerous, the fact that they are returning at all may signal a loosening of lending standards and a general improvement in the housing market since the mortgage meltdown back in 2006.