Interest only loans

I am having trouble understanding the hoo-hah and drivel surrounding interest only loans.

There are continual reports and articles by so called expert journalists expounding doom and gloom warning that millions are about to lose their homes all due to the borrowers stupidity and having the temerity to acquire interest only mortgages.

Human nature is such that we will believe anything which falls in line with our hopes and desires because we want it to be true.  Financial Services Providers [FSP] know this and advertise their products to appeal to satisfying those hopes and desires.  Nothing knew and something of which we are all well aware.

The FSP throws out a carrot to vulnerable people [all of us] by offering the dream couched in glowing rhetoric.  People look past the 95%+ leverage and the interest only nature of the loan because they can now afford to get into their own home and stop paying rent and the world will now be a place of joy and abundance.

Providing the numbers are correct in terms of affordability and our countries’ economy is solid, this cannot be a bad thing on several levels including growth in the building industry and giving people a smile.

However, FSP’s are treading a fine line to profit because they know an economic hiccup may cause issues.  Even if employment is strong any downturn in prices will see the people who were sold the dream drop into ‘temporary’ negative equity.  This is not an issue for the borrower as property prices will increase eventually but it is an issue for the lender or those people who sold the dream.  Why?  Because their loan books have also hit negative equity and they may even be trading insolvent because they have lent more than their assets cover.

So, it’s not the borrower who has the immediate issue, it’s the lender having overstepped their own risk parameters and panicking.

Everyone then panics driven by stupid sensationalist reporting and spending stops and the country slows causing even more panic and we all, lose the smile.

The issue is NOT interest only loans as this is merely a vehicle to pay and it’s the borrower who must face the consequences and pay the piper if the world’s economy implodes, terrorists blow up Christmas, Tsunami’s hit Uluru and/or unemployment rises.

The issue is leverage and equity.   If global economic meltdown happens and s/he loses their job then they have a nest egg or fail safe to be able to sustain payments providing they have paid off a portion of the loan.   This a comfortable place to be in knowing that even if the worst happens home will still be home.

So, to be able to sleep at rest, go for the interest only loan but with a leverage not exceeding say 90% and pay into that loan account every cent you can muster, live off the credit card and draw only enough to pay that credit card on the last day of interest free periods.  Two reasons, firstly it reduces interest on the interest only home loan and secondly builds a panic fund so if something does happen all is not lost.  Manage your debt and don’t let the dream makers profit at your expense.

And that is the issue.  There is nothing wrong with leverage and interest only providing you use the system to advantage and manage the debt.  I mean active hands on management knowing for example exactly when to pay credit card debt.  Know your commitments and build a simple spreadsheet of all debts on a time line so you know what needs to be paid and when.

The FSP’s know all this but prefer not to have to think about it by offering so called ‘vanilla’ home loans of principal and interest where loan exposure is reduced all the time.  This is an advantage to the FSP but not the borrower.  The FSP’s then load the interest rate for interest only to dissuade people from this type of loan because they know, if it’s managed, they will lose profit.  Worse, the borrower has no fail safe.