With rising interest rates putting the pressure on adjustable mortgages, a new type of loan product is gaining in popularity.
The fixed-rate interest-only mortgage gives the security of a fixed interest rate and the low monthly payments in the early years.
Borrowers are able to lock the interest rate for the life of the loan. The interest-only period usually lasts for the first 10 to 15 years.
The fixed-rate interest-only is barely two years old, but now accounts for almost 8% of all new residential mortgages, says UBS AG, a financial services firm. Roughly $39 billion of these mortgages were taken out in 2005, up from $7.9 billion in 2004.
With rates climbing to their highest levels in recent years and the gap between short-term and long-term interest rates closing, the demand for fixed-rate interest-only mortgages has risen. The cost of adjustable mortgages, which are usually associated with interest-only options, have climbed faster than the rates for fixed mortgages.
U.S. Bancorp added a fixed-rate interest-only package to its lineup in September.
Most mortgage companies point to first-time homebuyers as their biggest customer for the new product.
These mortgages are not without drawbacks. Borrowers who are only making interest payments on their homes aren't building up any equity, apart from the increase in property values. Once the interest-only period ends, the homeowners can be hit with sharply higher monthly mortgage payments.
The savings may not be as great as you would expect. Fixed-rate interest-only mortgages carry a higher interest rate than the traditional 30-year mortgage. Also, the majority of the interest is paid in the first years of the loan.
Fixed-rate interest-only mortgages are just the latest in a long line of non-traditional mortgages designed to boost affordability. Many of these mortgage products helped fuel the increase in home prices and allowed many homeowners to tap the equity in their homes. But banking regulators are weighing in on what risks these products may pose to both lenders and borrowers.
