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Author: jkrihak Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 308858  
Subject: Interest Only Mortgage Date: 9/16/2005 8:28 AM
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I met with a financial planner last night. A key part of his company's financial strategy is for a homeowner to have a rolling 5-year interest-only mortgage. The idea is that you make more investing the principle in other areas than in your home - I said to make this work, at current rates, my portfolio needs to generate more than 6% return for it to pay out (assuming my home increases in value an average of 6% over the next 5 (to 30) years. Anyway, I'm not sold on this proposition, but need to hear from anyone if this is a strategy that is worth looking into further.
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Author: RingwraithV Three stars, 500 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210816 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 10:28 AM
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Not to be too glib, but get a different financial planner. in a Bull market, it might make some sense. What happens in a market downturn? What did he/she say about refinancing every five years...there's an additional several thousand dollars you'd have to recoup, plus any added interest that may crop up (rates are likely to push up a little over the coming years). What ifyou need to sell the house and the housing market softens...you could sell for a significant loss.

Paying off a house is one of the surest ways to build wealtht that exists. I don't know what your income is, or what the value of any home you may own is, but look at it this way: paying off your house early returns a rock-solid 6% return on the overpayment. Once the house is paid off, you've freed up X thousand dollars in cash flow that can be invested. And this, comparitively, has no risk.

Just my 2 cents,

RingwraithV

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Author: Patzer Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210817 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 10:52 AM
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A key part of his company's financial strategy is for a homeowner to have a rolling 5-year interest-only mortgage. The idea is that you make more investing the principle in other areas than in your home

Key questions: Does this financial planner have a 5-year interest-only mortgage in order to be able to invest more? If so, how long has he had it? Has he rolled it over to a new 5-year interest-only loan? How long has his firm been recommending this strategy?

I cynically believe that the answer to the first question is likely to be no. If the first answer is yes, I cynically believe the answer to the second question is going to be under two years, and when the planner got it probably coincides with when he started selling this advice. Before interest-only mortgages were available, the planner (or the firm he works for) was probably telling people to do cash-out mortgage refis in order to invest.

I said to make this work, at current rates, my portfolio needs to generate more than 6% return for it to pay out (assuming my home increases in value an average of 6% over the next 5 (to 30) years. Anyway, I'm not sold on this proposition, but need to hear from anyone if this is a strategy that is worth looking into further.

Your thinking is sound. What the house does is not relevant. The relevant question is whether you can earn more than 6% on your investments with an acceptable level of risk. The deal is a straight pitch to invest with leverage, only with a twist of having the debt secured by your house. I don't like it. If I want to invest with leverage, I'll use margin or options and not put my house at risk.

Right now I'm not big on leverage at all, but I can see that it is appropriate for more aggressive investors. I happen to think that using mortgage funds as leverage for investments carries risks out of proportion to the benefit, but that's just my opinion.

Patzer

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Author: MacNugget Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210818 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 10:53 AM
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In general I am very wary of any financial plan that depends on everything working out perfectly in order to be successful. The number of things which can go wrong with the approach described makes my head spin and I'm far too cautious to do something like that.

There is no shortage of "clever" financial plans that can put money in your pocket if everything goes exactly as you hope. This approach appears to be one such plan, but the risk is substantial. I have nothing inherently against "clever" investing, but I'm not sure your home is the best place to try it. Even an aggressive investor is well-served by applying a more conservative approach to assets in their life which are not solely investments. We're talking about not just a large investment, but also your home.

Is the potential for additional income worth the undeniable increase in the risk of losing your home in the event of a financial hardship?

Warren Buffett has said that it's a bad idea to risk something that is important to you in order to earn something that is unimportant to you. Don't risk something you need in order to earn money you don't need. I can't disagree with that.

The best case scenario is that you earn a couple or three percent more on the amount of money you would have contributed to the principal of your home over the course of five years. I suspect that if you do the math, this is not a particularly large figure, even in the best case. Sure, it's more, but it's not much more. We're talking a difference of a few percent on just the principal you might have otherwise paid towards your equity.

I'm not sure I understand why you think that your home value increasing is a factor. That's going to occur (or not) the same in either scenario. You're not talking about cashing out that increase in equity (if it occurs) for investing are you?

On the flip side, the worst case scenario is pretty cataclysmic. You could lose your house. Your outside investments could falter in a terrible economy, interest rates could triple, and you could find that you no longer qualify for a mortgage large enough to "re-purchase" your home at the conclusion of your five year interest-only mortgage. Is it worth exposing yourself to that risk to earn the few extra percent on the money you might have otherwise paid into your home?

If you want to become more aggressive in your investing there are plenty of places where it makes more sense to accept that risk than with your home.

Personally, I try to lock in the lowest interest rate I can for a duration no shorter than I expect I might live in the home. That's a cautious approach, but we're talking about my home, not an investment.

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Author: MaestroCindi Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210823 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 11:18 AM
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Since interest rates are going up, if this is a home you plan to stay in over 5 years, I think locking in a fixed rate now makes more sense (I'm thinking interest rates in 5 years on mortgages will be higher). If you know you'll move in 5 years, than an interest-only mortgage might make sense. But IMO, if an interest-only mortgage is the ONLY way you can afford the home of your choice, than you can't afford that home.

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Author: Mark12547 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210831 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 12:16 PM
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A key part of his company's financial strategy is for a homeowner to have a rolling 5-year interest-only mortgage.

Are you saying that you refinance to a 5-year interest-only mortgage every 5 years? Hmm...

1. Mortgage rates are still quite low. Everyone is expecting that mortgage rates will be going up. So while today it may be appealing to have minimized mortgage payments and invest the rest, in five years we may be looking at historical average rates, and in ten years we may be looking at stagflation interest rates.

2. Even Alan Greenspan referred to "froth" in the residential real estate market. ("Froth" = not a national bubble, but many regional areas where home prices appear to be higher than normally sustainable.) If you are paying only interest and your home price declines, you may find yourself in the unenviable position of having to bring cash to the table if you sell. At least with typical mortgages where one is paying down the principal, over time the spread between the mortgage balance and the FMV of the house increases, continually reducing the risk that one would have to bring cash to the house to sell it. (Typically, figure that about 10% of the selling price will be eaten up when one sells, such as repairs inspectors find, 6% selling commissions, 1% transfer fees and the like.) The risk is particularly great when one has purchased near peak prices with 90% to 100% financing.

3. Each time one refinances, there are costs in the form of appraisals, loan originating fees, possibly items that may need to be brought up to code to meet requirements of the lenders.

4. There is the risk that one wouldn't qualify for refinancing at the end of 5 years, such as by an interruption in one's job, a serious black mark on one's credit report (and it isn't unusual for someone's black market to appear on another person's credit report, either through error or identity theft, or problems caused by a loan one cosigned for). Note: a typical Interest-Only loan isn't really a loan type, but a feature of a loan. So, for example, one could get an ARM with a 5-year fixed rate and a 5-year IO feature, but at the end of those five years both the rate adjustments and principal payments will kick in, which may end up being a double whammy on one's budget if one can't refinance at good terms at that time.

5. For one to come out ahead, one would need to get better results where the money is that one isn't spending on the mortgage. To beat the mortgage, one would generally need to take on risks of being in the stock market, complete with its volatility and risk. One risk is that after ten or twenty years, it may be more profitable just to pay off the mortgage than be invested in stocks. Another, larger risk is that one would do far worse than the market (as the Dalbar Study and many mutual fund family studies have shown: the "average investor" way under-performs the investments they invest in). One needs a disciplined approach to investing so one isn't chasing performance (buying investments after they experienced their run-ups) or allowing greed and fear to take control of investment decisions (buying high when everyone is saying you are a fool to not invest, and selling when the bubbles inevitably pop, when everyone is saying you are a fool for remaining invested).

While I think it is good to follow a decent investment plan while carrying a mortgage, I think the financial planner you saw is carrying it to an unhealthy extreme.

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Author: jkrihak Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210833 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 12:45 PM
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Thanks for the insight, everyone. I can respond to a couple of the threads to show my current situation and that of the planner's:
- I have a 30 year fixed @ 5.875%, plus a variable HLOC @ prime +1 - think 80/10/10 mortgage
- The planner follows the refi every 5 years, interest only plan, and has for the past 5 years or so since he joined the company
- The 6% growth is to provide some sort of benchmark should I need to sell my home. We have no plans of moving as our location is too perfect for my family's needs.

Doubt this changes much of what's been said, but I agree that the fixed rate is the way to go. Much appreciated.

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Author: DeltaOne81 Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210835 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 12:48 PM
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Worst... idea... ever...

While the previous posters did a great job of explaining all the ways and reasons and numbers behind this awful, no good, very bad advice, I'll sum it up as follows.

Very high risk (losing your home/unable to sell your home) under numerous circumstances... very low reward (getting a few percent extra per year after taxes) - why would you possibly?

If I was you, I'd contact the local realtors association/BBB/whatever and report this guy and his company, for dangerous conduct bordering on unethical.

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Author: Fuskie Big funky green star, 20000 posts Top Favorite Fools Old School Fool Ticker Guide SC1 Red Winner of the 2010 Rule Breakers Challenge Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210845 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 1:40 PM
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Let me me more succinct. Unless you are a professional investor, do not borrow money to invest in the market. This means don't refinance your home, draw on your HELOC, take a 0% cash advance on your credit card, hit your spouse up for a 10-spot, or raid your childrens' piggy bank.

Fuskie
Whose spidey sense went off as soon as he read "interest-only mortgage"...

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Author: jrsmith13 Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210848 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 2:16 PM
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Run. Don't walk, run.

Julie

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Author: Patzer Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210852 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 2:47 PM
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We have no plans of moving as our location is too perfect for my family's needs.

This is relevant information. If your location is perfect, retiring the mortgage and living in a paid-for home should be one of your goals. An interest-only mortgage is in direct conflict with this goal.

I can understand the interest-only mortgage on a home that is a speculative investment, i.e. you expect to move in a few years and hope to sell at a profit. If you have no plans to move, the endgame isn't to sell at a profit. The endgame is to retire the mortgage and live in your home for the cost of taxes, utilities, and maintenance.

Patzer

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Author: StrugglingAlong Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210869 of 308858
Subject: Re: Interest Only Mortgage Date: 9/16/2005 10:03 PM
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4. There is the risk that one wouldn't qualify for refinancing at the end of 5 years, such as by an interruption in one's job, a serious black mark on one's credit report (and it isn't unusual for someone's black market to appear on another person's credit report, either through error or identity theft, or problems caused by a loan one cosigned for). Note: a typical Interest-Only loan isn't really a loan type, but a feature of a loan. So, for example, one could get an ARM with a 5-year fixed rate and a 5-year IO feature, but at the end of those five years both the rate adjustments and principal payments will kick in, which may end up being a double whammy on one's budget if one can't refinance at good terms at that time.


We almost bumped into this. We had purchased a duplex with another couple. They decided rather abruptly to move after 5 years. We had no interest in leaving the house at that time, and indeed, liked the idea of taking over the whole thing. Unfortunately, DH (the primary earner) was unemployed with student loans - strictly a liability. Fortunately, Fleet was willing to take the other couple AND my DH off the mortgage for a minimal fee (like $400), and no hassle. I still can't quite believe they approved me on my pitiful income, but it worked out well in the end.

We really liked living in that house for the next 5 years.

SA

SA


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Author: JustGeorge Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 210897 of 308858
Subject: Re: Interest Only Mortgage Date: 9/17/2005 3:42 PM
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I would not do it as I think for myself that owning your home outright should be what your striving for and refi-ing every 5 years with a interest only mortgage would not accomplish that.

The usual average of apperciation for homes is about 3% not 6% and using the 6% figure is aggressive especially if the Fed continues to put the brakes on raising interest rates trying to slow the economy down.

Get a traditional mortgage and whatever you have each month extra use that for investing do not use your home in the manner that this guy wants you to.
Just my humble opinion.

--George

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Author: mew5280 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211179 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 12:53 PM
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How about this scenerio:

- Own a home in an *hot* area that has been appreciating at a rate of 8%/year for the past 6 years.

- Will still have 30-40K equity in the home after the refinance.

- Have significant CC debt that you are trying to clear (unusual debt, due to job loss, not an ongoing problem with spending)

- Are planning to definitely move within the next 5 years.

Would it make sense then to take the interest only and use the extra $$ to pay off the CC debt?

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Author: timso42 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211181 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:22 PM
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Bad idea.. except probably for the financial planner.

Looking at an amortization chart, it seem to me it would be more effective to take the tax return that you get from the interest on your mortgage (I am going to pre-assume that you are living in the US and you are potentially getting a refund from the interest on the mortgage) and invest than to risk your house. However at the same time (and in line with RingWraithV) it may make more sense to take that same tax return and put a one-time payment on your house, which nets an effective 6% return on the increasing equity (using the 6% asssumption on your house value).


We have to be a little more creative up here in the great white north as we don't get the interest deduction on a mortgage.


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Author: bomer00 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211182 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:31 PM
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Your planner is right is spite of the popular notion that it makes sense to have a lot of equity in your home. Fact is the rate of return on home equity is zero! Home equity is neither safe, secure or liquid. Just ask those people in New Orleans who owned their homes free and clear and had them washed away...Home equity is one of the few remaining tax breaks available and it NEVER makes sense to pay principle on a house for the reason stated above...How do I know this? Because I have done this myself and I am about 150k richer in one year than i would have been leaving my lazy, idle equity in my house..If you want more info check out Missed Fortune 101 by Douglas Andrews...enjoy!

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Author: afamiii Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211183 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:33 PM
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I have had an interest only mortgage (for 25 years, NOT rolling 5 years) for just over 5 years.

I invest the difference between what I would have paid on a repayment, in equities. Half in an index fund (FTSE - my financial base is in the UK as is the house) and half in a self selected portfolio. Overall I need 5.5% to break even, I have so exceeded this.

Taking an interest only and investing the balance has higher risks and don't believe it is right for everyone. However, it also has the potential for higher returns.

To an extent the risk can be managed by regular reviews of your portfolio (monthly or quarterly) and if the portfolio is tracking behind then additional investment needs to be made over the next period.

This option also requires additional investment in time (and additional expertise). I was fortunate, in that I already managed my retirement portfolio (equities, real estate and bonds).

If you are prepared to invest the time, have a sound understanding of investing and the ability to successfully practice investment management, and have a financial surplus (not financialy constrained). Then it is worth considering.

Regards

Afamiii


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Author: acap73 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211184 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:34 PM
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OK, I don't get something here with this.

I'll use myself as an example.

I have a mortgage - it doesn't really matter what the terms are, the bottom line is that I have a HUGE loan.

I also have some money in the stock market (some money in mutual funds, some in retirement accounts).

So, based on the logic above, I should probably sell everything I have in the markets (even if I have to pay a penalty) and use that money to pay down my mortgage as much as possible. In fact, until I've 100% paid down my mortgage, I shouldn't even think about having any money ANYWHERE ELSE! After all, if I did that, effectively I'd be borrowing money to invest in the market (or a money market, or wherever else it might be).

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Author: jpsauro Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211185 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:34 PM
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A couple things that you need to add into your equation.

First, while your interest rate is 6%, it's a deductible 6% which means your effective rate is closer to 4%. So now your benchmark to beat is a more reasonable 4%.

Second, what's your time horizon? Over long periods the stock market has provided an unparalleled rate of return. If you're dollar-cost-averaging your savings into a low cost index fund and reinvesting your dividends you will almost certainly beat 4%, in fact, during bear markets this strategy will intensify your returns because you're buying shares at a discount. While the average return for the market over long periods is 10-11%, by reinvesting your dividends, your realized rate of return is much higher. I recommend Jeremy Siegel's latest book, “The future for Investors,” he has plenty of examples and makes compelling cases for stocks and stock funds.

This strategy assumes two key ingredients:
1. You must invest your mortgage savings, not fritter them away.
2. You must have the discipline to keep dollar cost averaging and reinvesting your dividends (DRIPing) even in down markets.

Jeff


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Author: acap73 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211186 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:37 PM
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>>Get a traditional mortgage and whatever you have each month extra use that for investing...

Again, I don't get this logic. By this logic, shouldn't he take any extra money he has each month and use it to pay down principle. Why is it appropriate to pay down a mortgage over 30 years but not 40? or 50? or for that matter 10?

The goal at the end of the day is to create wealth without enduring excessive risk. This person's risk tolerance is his own and only he can decide what the correct risk/reward balance is.

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Author: zeesterz Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211187 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:38 PM
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Like jrsmith said... RUN!

Your advisor has you on the edge of the fence and a grand offering of interest only offerings he's waiting to pounce upon you with. I emailed your story to my brother who's with Chase and all I got back was a page full of laughing smiley faces.

Fire the idiot. You're safer with your money stuffed in a mattress than you are with this guy.

Overpay your mortgage savings 10s of thousands in interest and invest the rest.

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Author: NaggingFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211188 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:38 PM
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Would it make sense then to take the interest only and use the extra $$ to pay off the CC debt?

Interest-only mortgages are a tool, and sometimes it makes sense to use them. You'll need to do a lot of arithmetic to figure out if they're appropriate in this case.

First of all there's no guarantee that a property will continue appreciating. It could even drop. Is there anyway you can reduce spending to kill off the credit card debt in five years without using the equity in your home?

If I were trying to make that decision, I would look at some numbers.
My goal would be to find out, "What assets would I have at the end of five years?"

I would then compare different scenarios, changing one variable at a time.

- Mortgage stays the same, refinance for lower interest rate but no cash out, refinance with cash out to pay the CC debt.

- House continues 8% annual appreciation, vs. house stays the same, vs. 20% drop in property values.

- CC rates stay the same, CC rates go up to default rates, CC rates are bounced around to teaser rates and average around 6%.

I would then look at how much I would have in five years under the different scenarios. I would look at how bad the worst case scenario was, and how likely I thought that was to happen. I would look at how good the best case scenarios were, and how likely I thought they were to happen.

Good luck!
- Megan


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Author: Patzer Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211189 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:40 PM
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How about this scenerio:

- Own a home in an *hot* area that has been appreciating at a rate of 8%/year for the past 6 years.

- Will still have 30-40K equity in the home after the refinance.

- Have significant CC debt that you are trying to clear (unusual debt, due to job loss, not an ongoing problem with spending)

- Are planning to definitely move within the next 5 years.

Would it make sense then to take the interest only and use the extra $$ to pay off the CC debt?


There are two thoughts here:

1) Cash-out refi of the mortgage, using proceeds to retire CC debt, and
2) Interest-only mortgage, planning to sell the house later at a profit.

Under the stated assumption that there is no ongoing problem with spending, point 1 could be considered. Whether it makes sense depends on the total financial picture, including risk of further unusual debt and stability of income stream. On this board, we don't like the assumption that there is no ongoing problem with spending. There are too many cases of that assumption being made, and reality failing to conform to the assumption.

Point 2 is a straight speculation in the housing market. It's a bet that the housing market will only go up, not down or even sideways. I don't like this bet. I tend to think that when people need interest-only mortgages to buy a house, housing prices shouldn't be rising a whole lot more or there will be no buyers who can afford the financing.

If there's enough cash flow to have a traditional mortgage, I don't like failing to pay any principal. If there is so little cash flow (even after retiring the CC debt) that an interest-only mortgage is all that can be handled, this is an incredibly high-risk bet on real estate prices.

I don't like this plan at all.

Patzer

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Author: larsens Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211190 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 1:52 PM
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Well, some may call me "foolish" but I have actually been doing this for the past 1 1/2 years. I did a 5 year interest only loan on our new house and have been investing the excess (plus a bit more, but I wont use that for this analysis) into a mortgage fund. The Fund is returning, on average, 9% for the past 7 years. As of today, I have accumulated close to $20,000 in this account, including interest. Comparable principle paydown on a conventional 30 fixed mortgage at 5.5% would show approx. $9300 paid on the loan balance. Furthermore, I show if I only earn 8% average on the mortgage fund (a relatively secure investment), at the end of the 5 year loan period, I will have accumulated almost $75,000 vs. $38,500 pay down on the 30 mortgage.

Now, refinancing and taxes will eat away at the difference, but I am failing to see the major downside to this plan.

It is very possible that something horrible happens and interest rates are way higher in 3 1/2 years or something happens where I can not qualify for a new loan. The industry pundits have been predicting interests to explode for the past 4 years and that has not happened.

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Author: mew5280 Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211194 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 2:06 PM
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Well, I actually did this, for the reasons stated above, in February of this year. BUT, I had a huge problem. My house was appraised during the refinance at $260K. (I originally paid $130K but had taken money out so my loan was at $185K). I was taking some money out during the refinance to pay some of the CC debt off, but not all so the total new loan amount was $204K. No problem I thought. I thought the 260K appraisal seemed high but was certain I could get 235-240K.

Went to a realtor to talk about starting the sale process when lo and behold, the appraiser really pulled the wool over my eyes. Apparently the going rate for a house like mine is at tops $215K. I got another realtor, same conclusion. I was ignorant about appraisals, should have done more homework but I didn't. My tax assessment assessed the house at $200K without knowing I have a finished basement and second full bath and cooling system in the house so I just assumed I could get 230-240K.

This is of course, very circumstantial. In addition though, I lost my job in May and was on a VERY limited budget until a few weeks ago when I started working again so having a lower mortgage payment was good for me.

I agree that buying a house initially with a no interest mortgage is not good. But in my case, I think I'm OK as I do plan on selling in a year or so. I took my equity already and am OK with that, it happened, it's the past, I have new future goals and better saving goals that I didn't have before. I will either break even or make a teeny bit when I do sell (unless I keep it a really long time).

I'm also lucky because my house is in an old 1940's neighorhood surrounded by brand new housing, schools, hospitals and shopping in a major city. The chances are very good it will continue to increase in value. It's an area where people are starting to pop the tops on older ranch homes (mine) and build up or out (huge lots).

So I'm not sorry I have an interest only but would only advise someone to do this if they own the home and have equity and plan on selling anyway within the length of the loan term.


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Author: SeattlePioneer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211195 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 2:14 PM
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<<Your planner is right is spite of the popular notion that it makes sense to have a lot of equity in your home. Fact is the rate of return on home equity is zero! Home equity is neither safe, secure or liquid. Just ask those people in New Orleans who owned their homes free and clear and had them washed away...Home equity is one of the few remaining tax breaks available and it NEVER makes sense to pay principle on a house for the reason stated above...How do I know this? Because I have done this myself and I am about 150k richer in one year than i would have been leaving my lazy, idle equity in my house..If you want more info check out Missed Fortune 101 by Douglas Andrews...enjoy!
>>


You make a lot of factual statements here that are only partially correct, and reccomend a financial strategy that can make money, but has a lot of financial risk you don't disclose.

Are you a financial planner, by chance?


<<Fact is the rate of return on home equity is zero! Home equity is neither safe, secure or liquid. Just ask those people in New Orleans who owned their homes free and clear and had them washed away...>>


Let's examine this statement to see how much sense it makes.

The price of houses has been going up fairly steadily in most parts of the country since about 1940. The objective fact is that most people who have bought and lived in a house for a decade or two have not only seen their house increase in value, but have reaped the rental value of living in the house as well.

Consuming the rental value of a home by living in it is one of the great benefits of home ownership --- which you ignore in your post.

As far as your remarks about New Orleans damage --- there certainly are risks involved in owning a house, and you probably are not going to be able to insure against all of them. But really --- being leverage out to the eyeballs isn't going to reduce that risk, is it?


You seem to support the idea of buying real estate, but not having equity in the property. That multiplies your risks in a lot of important ways, although it can have some advantages.

Personally I own my own home, and paid it off in about eight years. I bought rental properties both for cash and on credit. I've sold some of those properties and reaped the capital gains that you imply isn't there wwhen I did so. Having heaps of equity throws off free cash flow from rent which can can be invested in whatever I choose without the risk associated with highly leveraged property investments.

Sorry, but your advice above is bad, and it sounds like you really have little idea of what you are talking about.

I ask again --- ARE you a financial planner?



Seattle Pioneer



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Author: Dwdonhoff Big gold star, 5000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211197 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 2:25 PM
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WOW!!!

I just read through this entire thread... amazing... so few got it accurate.
Everyone else is falling prey to emotional assumptions, not financial logic.

We've run out a mathematical analysis many times, and have one hosted here for inspection;
http://www.nobullmortgage.com/30FRMvs5-1ARMComparison.htm

You can see it considers good, mediocre, and worst case interest rate environments against an average long term return of the S&P at 8.5% annual, roughly adjusted to 10% for an improved yield by being held in a tax-deferred retirement vehicle (which is an appropriate treatment for long-term investments to match long-term liabilities, such as mortgage leverage.)

It's always interesting to see people argue about short-term investment risks in comparison to long-term liability commitments.. an inappropriate mismatch of portfolio terms.

To dramatically simplify, the proper focus is to have your long-term tax advantaged investments earn more than the costs of your long-term tax-advantaged liablities, and then make a focused plan on directing as much discretionary income to your investments as possible, and not to the cheaper liabilities.

If an individual holds this as their "compass heading" and fits their strategies into this, they will accelerate their achievement of "Financial Freedom"... the point at which their assets throw off sufficient monthly income to cover their comfortable regular costs of living... making "woikin for a livin" no longer required.

Cheers,
Dave

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Author: Azotic Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211199 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 2:40 PM
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against an average long term return of the S&P at 8.5% annual

Your analysis is reasonable in its structure, but this assumption is outrageously optimistic. As they used to say in the computer biz, garbage in, garbage out.

Historical S&P appreciation has AVERAGED close to what you're guessing over very long periods of time, but at times when the typical valuation measures are as high as they are now, it's been a lot worse for long periods afterward.

I'm not making a prediction, just talking about averages -- but then, so are you!

-- Mark


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Author: SGR100 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211200 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 2:41 PM
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Why would you bank on the notion that you MAY earn more than 6% on investments rather than PAYING DOWN the LOAN on your home? A self-amortizing mortgage at the very least will give you the peacee of mind that if all else fails - at least you'll own your real estate at the end of the term.

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Author: SeattlePioneer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211201 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 2:43 PM
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<<OK, I don't get something here with this.

I'll use myself as an example.

I have a mortgage - it doesn't really matter what the terms are, the bottom line is that I have a HUGE loan.

I also have some money in the stock market (some money in mutual funds, some in retirement accounts).

So, based on the logic above, I should probably sell everything I have in the markets (even if I have to pay a penalty) and use that money to pay down my mortgage as much as possible. In fact, until I've 100% paid down my mortgage, I shouldn't even think about having any money ANYWHERE ELSE! After all, if I did that, effectively I'd be borrowing money to invest in the market (or a money market, or wherever else it might be).
>>


Succesful investing involves a lot of shrewd good judgement.

Debt isn't necessarily bad, but it usually adds to your risks.

Taking on debt to buy a house can be a reasonable thing to do, but leveraging yourself to an extreme adds substantial risk to your life if you lose your job, get ill, find you have to move, housing prices collapse or you have other problems.

In the situation you disclose, it might be worthwhile to retain your stocks, since selling them costs you in transaction fees and taxes. Furthermore, stocks are probably more liquid than equity in your house --- if an emergency occurs that requires cash, having the stocks available to sell makes good sense.

In your situation, having the HUGE loan is risky. But selling your stocks to marginally reduce the loan balance doesn't materially leave you safer. Having the stocks available to sell should you need to raise cash DOES make you safer financially.

But if you have a HUGE loan, I'd be looking for ways to hedge that risk. Buying less in the way of consumer junk and making a point of paying down debt or accumulating other cash or investments would definitely be something I'd be looking at.

That would be my analysis.



Seattle Pioneer

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Author: smallcapport Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211203 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 3:27 PM
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Time for a new financial planner. One of the best ways to achieve wealth is to pay down debt as fast as you can. The quicker a mortgage is paid, the more financial security you create for you and your family



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Author: JimWil101 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211204 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 3:29 PM
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Be wary of the term "financial planner" and "company's strategy" in the same reference. The real financial planners I know (and I am one) don't have a strategy going in and are free to suggest what seems appropriate. Every one's situation is unique and should be treated as such. This sounds like a sales rep. from some American-sounding company that just changed it's name to be more "enterprising." I have also heard of them recommending taking out a home equity loan and making the money "work harder." The only one working harder will be you trying to pay your mortgage. A good solution is unliikely to come from a memo from the head of sales.

When rates are at a 45-year low, why would you choose now to go adjustable? Unless you can't afford the payments and this is a truly temporary situation to get you back on your feet, stay fixed and pay every two weeks. That will reduce you payments and ensure your rate stays low until your next home. If you can't afford that, you can't afford to invest. Cut back on entertainment or liesure activities you can live without (going out, digital cable, cell phones, video games) and generate truly discretionary money for investing. You'll have a much easier life down the road.

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Author: evans123 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211205 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 3:29 PM
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I had this same conversation with an advisor about three weeks ago, and finally came to the conclusion that their motivation may be more about their financial outlook than mine. How convenient that they could do the refinance for me making 1 point off of me and 2.5 points from the lender, and then when additional cash was free for other investment "vehicles", who better than him, to be behind the wheel of my portfolio. I guess in principal there's a way to make this work, but when the person recommending it has more to gain from my actions than me, I smell a rat.

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Author: dale118 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211207 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 3:49 PM
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Lets assume (we all know what that spells) for an example You are able to pay more then just the interest payment. This means you have cash left over. You can invest the cash or you can pay down your note. Your choice. There is nothing in an interest only loan that says you can not pay principle down. You get to decide how much principle to pay. 2. How long do you want to keep the property? If you are putting 20% down and intend to only hold for 5 years. Maybe you do not care to pay down the note. You do not want to lock up any more cash then you have to. You are paying interest that is deductable off taxs. So you are probably living cheaper than if you rented. You sell at the end of 5 years and move to your next property. Or you just let the loan convert to a 1 year ARM. (thats what most interest only do) It does not cost anything to convert. What is the difference you pay in compared to a 30 year loan?
If you are going to stay long term. Lets say you simply bank the difference. If there is a down turn in the economy and everyone is dumping their homes proerty values are going down. You have a 20% down payment cushion. Now you have extra cash to put down on another house at a discount. You did not have to borrow the money on a second note to get the money. If the economy is crashing what is the FED going to do? They drop interest rates to stimulate the economy. Now you can refi the first note at a lower rate at no cost. Ask your loan officer how to do this.

Consider this if a 5 year Arm is 5.5% and a 30 year fix is 6% you can take out the 5 year pay your note like the fixed and be adding 1/2% interest to principle that would other wise go to the bank. It is a no brainer. Interest only gives you many options. Just like stocks. What is acceptable risk. The 30 year is fixed but are you going to keep your property for 30 years?

Finally, The FED has been raising rates since June of 04 I think. The past 15 months. Lets figure they raise them for 6 more months and the economy begins to slow down. They sit on rates for 6 months to a year. The economy needs stimulas? The FED begins to lower rates. You might be sitting in the perfect point in the rate cycle. When it come time for you to refi rates are going down. But who has a crystal ball?



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Author: JimWil101 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211209 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 4:05 PM
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There are no black and white answers here and actually, the terms of the mortgage are important. It's primarily an issue of cash flow and managing risk. If you have the money, it's not a bad idea to pay off the house and earn 6% or more a year on your "nest egg" as long as the house is maintained and is appreciating in value. Can you be guaranteed you'll do better than that elswewhere? No matter what happens you'll always have the equity in the house to fall back on.

There's also something to be said for having money to put elsewhere, not to mention the tax write-off of the mortgage interest. Since most people cannot pay off the mortgage, you need to manage the payments while creating equity. Otherwise, you never get off the treadmill. If you can create faster equity elsewhere, than it should be considered, but investing has inherent risks that should not be ignored.

No one said anything about incurring penalties or excluding everything else, but the risk in this idea is much greater than the benefit. Do you remember tech stocks in 1999? "Sell everything else and invest your money in the internet, you can't lose!!" At least not until 2000.

Just another opinion.

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Author: Iggywine Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211216 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 4:29 PM
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A rather fascinating series of comments, but one factor I haven't seen mentioned bears mentioning:

Assuming you have the interest only loan for 5 years, and the expected bursting of the proverbial real-estate bubble occurs, what happens when your home at the end of the five-year period is worth LESS than the principal amount of your loan? What bank will loan you 110%, 120% (or possibly more) of the value of your home? And if by some strange reason (i.e, they don't want it back... LOL) they DO decide to make the loan, what type of over-market rate will you be charged?

Not to mention that, knowing from my own experience that what doesn't go to the loan goes to discretionary spending (i.e., Starbucks and other waste...), how realistic is it that you'll actually put the difference into investments - and INCREASE that difference every month? (Remember, with a traditionally amortizing mortgage, the principal paydown increases each month - albeit quite slowly.....)

Just a few thoughts....

George


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Author: bargaindave Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211228 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 5:07 PM
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I believe that how you manage your leverage is more important than your success with raw investment picks. I'd look at my ratio of debt to assets. Debt to earnings. Debt to disposable income. A little leverage can enhance the return on an otherwise conservative financial picture. To much leverage may be your ticket to the huge set-back that will have you working the rest of your life for your creditors.

Do check out the total loan cost, pre-payment provisions, etc.

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Author: yFool One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211234 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 5:51 PM
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my 2 cents

this makes great sense if the cost of your home is small potatoes to you.

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Author: hoybie Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211238 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 6:01 PM
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Seems to me that this is really a question of risk tolerance. Being leaveraged is not necessarily a bad thing. Several poster posed the question a little differently: If you had some extra money, would you use it to pay down your note over and above the minimum payment? Several factors come into play here:
1) The rate on your mortgage
2) The risk and expected return on any alternative investment
3) Whether you can financially weather the risks involved should things go unexpectedly.
4) For interest only loans, you are obviously also introducing the risk of the floating rate/ refinancing every 5 years.
5) People borrow money to make investments all the time. I don't see that this is any difference except that the loan is tax-deductible against ordinary income and the rate is probably better than what you will get in other settings.
Personally, with the difference between variable and fixed rates being so small, I would be loathed to take out a interest only ARM unless I was planning on borrowing money anyway. I certainly don't think that taking out an interest only loan is the best thing for the average home owner but what might be not make sense for one person could very well make alot of sense to another. I don't think that blanket statements can apply here.


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Author: bankingintern Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211240 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 6:07 PM
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One thing many people have missed. The OP said Interest Only loan, not Interest Only ARM. The two are diffrent and confused by many.

He is looking at using one of many tools in the financial toolbox. At the right place and time, it DOES make sense to use this specific tool. Without knowing some more information, I can't say if the financial planner is wrong.

Two comments.

1. There are 30 year fixed rate Interest Only loans out there.

2.If you ARE going to use leverage in your investing a home mortage has some specific advantages.
First, the rates are lower than buying on margin.
Second, the loan isn't callable so long as you make the payments. This is an important feature if you want to fund long term investments (like retirement accounts) because it allows you to stay on an investment path even when the market is nutty.

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Author: JimWil101 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211243 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 6:36 PM
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A financial planner worthy of the title would consider this, but would not recommend it for someone else's money. I will therefore assume this person is not a financial planner. It is really a shame the titles people throw around these days. It makes the whole industry look bad and gives credibility to the scandal-hungry press.

A person's actions will indicate their best interests, regardless of their title. Any time someone pushes an idea without also presenting the alternatives an internal alarm should go off. And may these sycophants be exposed for what they are.

-JimWil101
Financial Planner

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Author: sailrmac Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211248 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 7:50 PM
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<<Fact is the rate of return on home equity is zero! Home equity is neither safe, secure or liquid. Just ask those people in New Orleans who owned their homes free and clear and had them washed away...>>


Let's examine this statement to see how much sense it makes.

The price of houses has been going up fairly steadily in most parts of the country since about 1940. The objective fact is that most people who have bought and lived in a house for a decade or two have not only seen their house increase in value, but have reaped the rental value of living in the house as well.

Consuming the rental value of a home by living in it is one of the great benefits of home ownership --- which you ignore in your post.

As far as your remarks about New Orleans damage --- there certainly are risks involved in owning a house, and you probably are not going to be able to insure against all of them. But really --- being leverage out to the eyeballs isn't going to reduce that risk, is it?


You seem to support the idea of buying real estate, but not having equity in the property. That multiplies your risks in a lot of important ways, although it can have some advantages.

Personally I own my own home, and paid it off in about eight years. I bought rental properties both for cash and on credit. I've sold some of those properties and reaped the capital gains that you imply isn't there wwhen I did so. Having heaps of equity throws off free cash flow from rent which can can be invested in whatever I choose without the risk associated with highly leveraged property investments.

Sorry, but your advice above is bad, and it sounds like you really have little idea of what you are talking about.

I ask again --- ARE you a financial planner?


Hi Seattle,

I can't speak for the poster but I am a financial analyst (not a personal planner) and neither of your statements is correct. Home equity "earns" a rate of return equal to the after tax interest you would have to pay if you did not have it. If a fair interest rate in your particular situation was 6% then your rate of return would be 6% or something like 4% after taxes. The amount of money the home appreciates does not depend on the equity you have in the property. Wether you have $1 dollar in equity or $100,000 dollars what you make from the appreciation doesn't change.

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Author: aforementioned Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211251 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 8:14 PM
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Curious to how you met this planner. Last Sunday, there was great article in the Washington Post (business section) on choosing a Financial Advisor.

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Author: snafflekid Big red star, 1000 posts Old School Fool Global Fool Mission Olympia 2 Motley Fool One Everlasting Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211254 of 308858
Subject: Re: Interest Only Mortgage Date: 9/22/2005 8:39 PM
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I am in the process of doing exactly what this financial planner suggests. I have a 5/1 ARM and HELOC 5% down in my home. The other 15% which would have been downpayment went into AAPL on 2/04 and I have done very very well. On my 5/1 ARM I have approx. a nine year window of time to evaluate my refinancing situation (break even to a 30 fixed)



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Author: SeattlePioneer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211265 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 2:42 AM
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<<I can't speak for the poster but I am a financial analyst (not a personal planner) and neither of your statements is correct. Home equity "earns" a rate of return equal to the after tax interest you would have to pay if you did not have it. If a fair interest rate in your particular situation was 6% then your rate of return would be 6% or something like 4% after taxes. The amount of money the home appreciates does not depend on the equity you have in the property. Wether you have $1 dollar in equity or $100,000 dollars what you make from the appreciation doesn't change.>>


I'm suggesting that there are two possible sources of financial return from owning a home. One is the possible price appreciation, the other the rental value of the home.

I'll agree with you that neither is related to how the property is financed. I didn't say it was.

I'm afraid I find your analysis obscure.



Seattle Pioneer

I'm afraid I don't understand the argument you are making in your second sentence.

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Author: Denis051 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211266 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 4:29 AM
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No end to the reply's here and quite an emphatic bunch, so here are my comments

Don't get caught up with all the noise and don't rule out the option given by the planner.

Some of the reasons for taking out an interest only mortgage

1 If your disposable income consists primarily of the principal element of your mortgage and you HAVE TO make alterations to you house or make repairs that you would otherwise have to borrow for then take out interest only.
2 If you ABSOLUTELY WANT to invest in stock and or additional property and you only have the amount available from the principal then take out interest only. This increases your leverage, which in turn increases the risk return – so figure out what amount of debt you are willing to accept. I have many clients that have amassed small fortunes because they refused to build up equity in their homes and instead invested to the hilt in additional property. I have no clients that have amassed fortunes from putting all their available cash into their home, but that being said they also have no worries about where they're going to live at retirement age.

Some of the reasons for not taking out an interest only mortgage.

1 Primary reason is that when you retire and your income stream reduces you still need somewhere to live, so no matter what financial plan you develop make sure it includes paying off your mortgage before retirement age. Interest only mortgages on the place you live are short to medium term solutions to enable you to free up cash. ( As for your house being carried away in a flood make sure its insured to protect your equity.)
2 If you're going to go interest only you must have alternative plans for paying off your home mortgage should the investments go south.
3 If you believe interest rates are going to increase there is no better time to pay down your mortgage than now.
4 If you have excess income over and above the principal requirements then why not pay down the mortgage and invest in other assets.

To give you some perspective on where I'm coming from.

I live in Ireland, which has been going through an unabated property boom for the past 10 years. With interest rates on home mortgages around 3.5% gross and unlikely to increase (as long as Germany and France remain unionised under-performing economies). As prices have reached all time highs the amount of banks offering interest only mortgages has multiplied and this has only increased the level of property investment. Our Economy is becoming highly leveraged which is a bit like putting your foot on the accelerator, you'll get to your destination quicker but the changes of wipe out should something go wrong increase dramatically. Most people are going interest only just to get into the market not so they can make alternative investments with the principal. If I were you I would only go interest only if I knew I could adequately cover an large increase in interest rates and meanwhile I could invest the principal somewhere else at returns far in excess of the rate of interest on my mortgage ( think 20% )
Don't spread yourself too thin but don't remain a one asset man either.
Best of luck.



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Author: Banno Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211281 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 11:36 AM
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Having read quite a number of the replies to your post I am left quite surprised. Being based in the UK things may be different but the Fools them selves advocate using just this strategy in their book 'The Motley Fool Investment Guide'. It suggests taking out an interest only mortgage and investing the rest in an Index Tracker (of say the FTSE 100). The justification being that historically over long periods of time the Market returns consistantly (I think at 8%). Moreover they even suggest not paying off the mortgage when there is sufficient equity in the Index tracker but to re-mortgage and leave the tracker going as compound interest works its best the longer it is in with the curve going exponential ?! Have they got it all wrong !?

I have not done this yet but I have a tracker and was thinking about it !


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Author: caromero1965 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211285 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 12:20 PM
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- The planner follows the refi every 5 years, interest only plan, and has for the past 5 years or so since he joined the company

So in other words, he's done this maybe once?

And lemme guess: He's the one who sells you the other investments.

Can I get a job like his?

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Author: caromero1965 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211287 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 12:26 PM
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To dramatically simplify, the proper focus is to have your long-term tax advantaged investments earn more than the costs of your long-term tax-advantaged liablities, and then make a focused plan on directing as much discretionary income to your investments as possible, and not to the cheaper liabilities.

Never heard it put that way. Makes perfect sense, though. Got my rec.

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Author: ichor0416 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211319 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 3:25 PM
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Answer depends on your circumstances:
- anticipated term of residence
- your view of interest rate movements and rate volatility
- tolerance for interest rate risk
- RECOGNITION OF ASSYMETRIC RETURNS FROM IO mortgage rollover

How high can your rate reset before it is too high for you on an after-tax basis? Chances are better than 50/50 that it will be at least 2% higher than it is today.

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Author: synchronicity Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211321 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 3:35 PM
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I met with a financial planner last night. A key part of his company's financial strategy is for a homeowner to have a rolling 5-year interest-only mortgage. The idea is that you make more investing the principle in other areas than in your home ...I'm not sold on this proposition, but need to hear from anyone if this is a strategy that is worth looking into further.

Warning, this is really long and scrolly:

Many posters have said some similar things, but my thoughts:

A) First of all, the basic question in any suggestion regarding paying down a mortgage balance (which applies to 30 year vs. 15 yr., or any regular mortgage vs. an IOM, where you don't pay down principal for a period of time) is "should one invest excess cash elsewhere, or pay down the mortgage?"

Looking first at that question, without regards for type of mortgage, that boils down to "what after-tax rate of return can you expect over the time period you are likely to hold the mortgage, vs. the after-tax interest rate on the mortgage"? Note that expected rate of appreciation on your house is generally NOT part of this equation (save in one area, which I'll get back to at the very end of this long scrolly post).

This question drills down to a couple of sub-questions (if it feels like this is almost in "outline" format, that's kinda how it's going through my head). First, let's assume a “simple” situation: you just bought a house with a 30yr. FRM, and know with certainty that you will be living in it for the next 30 years (yes, I know there's always uncertaintly. I'm starting simple, OK?). Let's say that the interest rate on the mortgage is 6%, all the interest will be deductible, and your tax rate with regards to those deductions (usually your top marginal rate) is 33%. Your after tax interest rate for the next 30 years will be 4%.

Now, your after –tax rate of return on investments may very well be over that 4% over the next 30 years. Setting aside the mortgage issue for a minute, the issues to look at are 1) would you actually invest any “extra” funds that could otherwise be used to pay down the mortgage, and 2) how would you invest those funds, given your personal risk tolerance. Over a 30 year time frame, investing primarily in equities may well be your choice, but many people can not handle the volatility of equities psychologically regardless of their financial situation and investment time frame.

If past history is any indication of the future, of a 30 year period of time it is highly probable that an investment such as a broad-based equity index fund will return well over 4% after-taxes (index funds are very tax-efficient investments, as they have minimal transactions, so taxes are predominantly on dividend payouts). If one were to also invest at least partially in bonds (either directly through TreasuryDirect or other means, or in a low-expense broad bond fund such as Vanguard Total Bond Market Index), it is possible that the after-tax rate of return from such a fund would exceed 4% over a 30 year time frame. (You can look up historical bond rates at the Federal Reserve Economic Database).

Having said that, with a FRM, your interest rate is fixed. Your effective tax rate will vary over time, which ahs some impact on the “effective after-tax rate”, but such fluctuations are likely to be fairly small for most people.

By contrast, bond returns can fluctuate considerably from year to year, and stock returns, as we all know, can fluctuate very much from year to year. Over a long period of time) like 30 years), such fluctuations will not be as important (the “range” of returns for equities over a 30 year period of time may be, say, 6% to 12% annualized, but for a 5 years it could be -10% to 25% annualized). So, first one has to consider “roughly, what is the chance that my investments will yield a greater after-tax return than paying down the mortgage, and by how much?”

Once one has some idea of the answer to that question, you have to think “OK, personally, how do I feel about getting an uncertain 7% per year (for example) vs. a 'certain' 4% per year?”

What makes this difficult is that you're not dealing with hard and fast numbers, but rather with probabilities. You don't know that you'll get 7% per year on your investments after-tax, you can only say that that's your best guess, given the way things have done in the past and your likely investment choices in the future. You really need to have some idea of what the “best guess” is of both the average and the range around that average (roughly 7%, plus or minus 4% each way, say). With an FRM, the interest rate is fixed, the tax rate is not but you can guesstimate that range and know that won't make a huge difference (even if your tax rate were to zoom from 33% to 50%, your after-tax interest rate would only change from 4% down to 3%).

A last uncertainty is “how long are we going to be in this house?” You may be planning on staying there for 30 years, but things happen. Now, if these are good things (you're making scads more money, you win the lottery, etc.) then you won't really worry too much if your investments didn't do quite as well as paying down the mortgage. But if you're leaving for a neutral reason (job transferred to another city, say), or a bad reason (lose job/health issue/etc.), then you have i) the possibility of a shorter time frame (and a wider “range” of returns) for investments, as well as ii) the fact that a “bad” return on investments would make your situation worse. Along these lines, keep in mind that “bad” events are often correlated. If the economy goes south, you may lose your job, have the value of your house drop, AND have your investments do poorly.

A last bit on investing vs. mortgage: one advantage to investing is that whole “diversification” thing. You have assets outside your house, and they are more liquid. You can always sell stocks or most bonds at a moment's notice at little cost. With a house, you can't really sell part of it, selling the whole thing takes time and has high costs. You can get around that a bit by getting a HELOC and not using it save for emergency, but then you're introducing the uncertainty of interest rates on that if you need to draw on it for emergencies.

I'm making this more complicated than it needs to be. Just think, baseline: A) which will have a better return, paying down the mortgage quicker or investing that cash elsewhere? The side bits to that are 1) what would I invest in, and 2) what's my time frame for those investments? Then think B) OK, given my guess on return paying down mortgage vs. investing, what do I feel more comfortable with? Is the risk of investing worth my best guess at increased return? How much of my assets do I want in my house vs. elsewhere?

B) The above was the long bit, because it covers the main issues, namely “risk and reward of paying down mortgage vs. risk and reward of investing”. Now, by changing the type of mortgage you're now playing with the risks on the “mortgage” side of the equation. With regards to an IOM…

With a fixed rate IOM, what you are essentially doing is increasing the amount of money you can set aside in “other” investments during the interest only period (generally the first ten years, IIRC) and decreasing it for years 11-30 (when you start amortizing the principal). So once again, you're looking at the same questions as above (what time frame am I looking at, “return” on paying down mortgage vs. return on investment.). The “extra” risk is that, essentially, you're looking at a shorter time frame for your investments.

Let's imagine, instead, that you get an adjustable rate IOM (an interest only ARM, or “IO ARM”). In this situation, you have an extra variable: the fluctuation in mortgage interest rates. In prior examples we've compared an “estimated” investment return vs. a (relatively) fixed mortgage interest rate. With an ARM, the mortgage rate will fluctuate as well.

Personally, I can't imagine why anyone would want an ARM at the current time. Interest rates are at historic lows, and are unlikely to go much lower. The exception to this would be an ARM where the rate is fixed for a number of years (5 is the most common) before changing to a variable rate, but only if one does not plan to stay in the house for more than a few years after the rate becomes variable. This is assuming that interest rates follow historical norms and are generally higher in the future than they are now. (As an aside, we initially had a 5/1 ARM when we purchased our house, as we believed we would not stay there longer than 7-8 years at the most. After a year we realized there was a significant chance we would stay there for longer, so we refi'd to a 30 year FRM).

Anyway, getting an ARM, be it interest only or “regular”, means you've introduced another variable (future interest rate fluctuations) into your “pay down mortgage or invest” question. In addition to evaluating uncertain future investments on the one side, you must evaluate uncertain future interest rates on the other.

The recommendation by this financial advisor seems to be the worst of all possible worlds. He's recommending getting an interest only mortgage and investing the difference, which is fine as far as it goes (since interest rates are quite low right now), but doesn't seem to take into account your personal risk tolerance. What he's suggesting is an aggressive strategy.

However, he is also suggesting “refi-ing every five years”, ostensibly so that you never have to pay down principal. This is a VERY aggressive strategy, and by “aggressive”, I mean “only suitable for people with a very high risk tolerance in their investments”, as you are always highly leveraged. Second, by doing this “refi every five years” you are essentially taking on an adjustable rate mortgage, because obviously, the rate will change every five years.

Third, refis have costs associated with them, usually several thousand dollars (depending on a number of factors). You can reduce these costs, but usually only by taking a higher interest rate (rather than pay $2500 and get a 5.5% mortgage, you could get a 5.75% mortgage and get a credit of $1000 towards your closing costs, for example).

So this “rolling refi” strategy is essentially “leverage your investments as much as possible, with an uncertain variable future rate that is likely to go up and with significant costs associated with that”. Uh, ohhhkayyy….

The fact that he's “been doing this for five years” is kinda like a stockbroker in the late 90's saying “I've been buying internet stocks on margin for 5 years and it's been a great strategy!” The last 5 years have been unusual in that interest rates have plummeted to historic lows while housing prices have jumped significantly (in some parts of the country they have increased dramatically in amounts unseen in the last 30+ years). Remember what I said about “events being correlated”? If interest rates increase significantly in the next 5 years, what do you think will happen to home prices?

So, to summarize all of the above, if you're debating between paying down a mortgage vs. investing any excess, you want to estimate the after-tax interest rate on the mortgage vs. the estimated after-tax return on the investments. By getting an IO mortgage (no word on if that's fixed rate for the next five years, or adjustable at some point in those first five year), you are essentially taking the maximum amount of money you can and choosing to invest it, which is a very aggressive, highly leveraged strategy. The alternative (paying down the mortgage) has a low fixed rate for five years at most (assuming the IOM is fixed for five years) and is likely to have a higher rate in the future. (And unlike an ARM, which can generally only move a few percentage points a year, your refi will be at whatever the prevailing market rate is). In addition, you will have to pay additional costs every five years when you refi.

Last, remember way up at the top (yes, long long ago) when I mentioned that there was only one aspect to home appreciation that was important. Well, here it is, and it was touched on by another poster. Imagine if you will that interest rates increase in the next five years. It is possible that your home might appreciate very little, or even drop in price (yes, it's happened before, if you don't believe me look at http://www.freddiemac.com/finance/cmhpi/current/excel/msas_old.xls . A particularly dramatic example is Houston from 2q1982 to 4q1987). With an IOM, you never pay down principal. So now imagine that it's five years later and you want to refi your IOM, but your house is worth less than the amount you owe on your existing mortgage. Hw exactly will you refi?

That's yet another risk involved with this strategy, which your “financial advisor” has conveniently glossed over.

Now, maybe, in spite of all the above comments, this strategy makes sense for you, if you are a highly aggressive investor with considerable other liquid assets that will allow you to handle any of the potential pitfalls. But for most people, the strategy would not be appropriate. At the very least, it requires a lot more explanation than “you could make a lot of money” and “I've been doing it for the last 5 years, and it's been working for me”.

But what do I know? Anyway, hope you made it to the end of this post without a headache.

-synchronicity


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Author: synchronicity Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211322 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 3:37 PM
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the Fools them selves advocate using just this strategy in their book 'The Motley Fool Investment Guide'. It suggests taking out an interest only mortgage and investing the rest in an Index Tracker (of say the FTSE 100).

You may notice that the Fool message boards often have a different tone than the Motley Fool Investment Guide.

I would also note that in my view "The Motley Fool Investment Guide" is useful mainly as kindling.

-synchronicity

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Author: NaggingFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211323 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 3:44 PM
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You may notice that the Fool message boards often have a different tone than the Motley Fool Investment Guide.

I recommend "The Only Investment Guide You'll Ever Need" by Tobias instead.

- Megan


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Author: synchronicity Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211324 of 308858
Subject: Re: Interest Only Mortgage Date: 9/23/2005 3:47 PM
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<< You may notice that the Fool message boards often have a different tone than the Motley Fool Investment Guide. >>

I recommend "The Only Investment Guide You'll Ever Need" by Tobias instead.


Well, yeah, for reading and advice and all that, sure.

However, if you need to start a bonfire and want the perfect bit to get that ignition going, "The Motley Fool Investment Guide" can't be beat. Just rip a number of pages up and set fire to the picture of the Gardners with their jester hats.

-synchronicity

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Author: TheMarchHare Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211349 of 308858
Subject: Re: Interest Only Mortgage Date: 9/24/2005 7:34 AM
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I was once presented with choosing between an IO and a repayment mortgage. One only needs to run the numbers to see in many cases that the monthly payments over the same time horizon are not that much different from either option. I realize that since the equation is parabolic that the differnces can increase at a faster rate at some time so it does depend on the time horizon of the loan, the principal maount borrowed and the itnerest rate, and the tax advantages, if there any (here in the UK, you can't write off interest of noninvestment properties). But with the set of numbers that I was using, those were my results.

I think the Average Joe investor needs to be honest as to how much time they're going to give their other investments to insure that they grow at a rate to cover the loss of the advantage to increasing the ownership value in their home. As well, over time, you could take out a flexible mortage and borrow against your property if you're so sure about other investment options.

But for less savvy and active investors like myself, I prefer the idea that I am increasing my ownership in an important asset that's already saving me money (ie the cost of rent each month).

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Author: slescohier Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211351 of 308858
Subject: Re: Interest Only Mortgage Date: 9/24/2005 8:53 AM
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I'm fairly surprised that a financial advisor would come up with that strategy, but I wonder what instructions you gave to the advisor. Plans should corespond to investor preferences and circumstances.

Did you ask for leveraged speculation?

The answer is not clearcut because it's not unreasonable for a person to own a securites portfolio while still having some mortgage debt on the primary residence. That could be viewed in a similar way as the recommendation might be viewed. In other words, if you have NO mortgage debt, and NO securities portfolio, I could see the idea of discussing some balance. From your description, however, I do not like the sound of the recommendation.

As a separate comment, I think for a significant number of people, the zero interest mortgage structure is going to cause trouble. I don't really like the zero interest mortgage product.

sal

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Author: Mark12547 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211357 of 308858
Subject: Re: Interest Only Mortgage Date: 9/24/2005 4:33 PM
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As a separate comment, I think for a significant number of people, the zero interest mortgage structure is going to cause trouble. I don't really like the zero interest mortgage product.

What do you mean by "zero interest"? You don't really mean a mortgage where you aren't charged any interest, are you?



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Author: Booa Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211366 of 308858
Subject: Re: Interest Only Mortgage Date: 9/24/2005 6:38 PM
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Your planner is right is spite of the popular notion that it makes sense to have a lot of equity in your home. Fact is the rate of return on home equity is zero! Home equity is neither safe, secure or liquid. Just ask those people in New Orleans who owned their homes free and clear and had them washed away...Home equity is one of the few remaining tax breaks available and it NEVER makes sense to pay principle on a house for the reason stated above...How do I know this? Because I have done this myself and I am about 150k richer in one year than i would have been leaving my lazy, idle equity in my house..If you want more info check out Missed Fortune 101 by Douglas Andrews...enjoy!

I would say that your example actually shows the opposite. If someone has paid off their house and it gets washed away, yes, they have no house, but they also have no loan. If you have no equity in your house, and it gets washed away, you still owe the money on the loan, and you have no house. Maybe you pulled out equity into other investments, and thus have that money when your house washes away, but you will still owe the loan.

The loan doesn't magically disappear just because the house does. How much have you made on your house taking into account what you still owe on your mortgage?


--Booa

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Author: slescohier Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211369 of 308858
Subject: Re: Interest Only Mortgage Date: 9/24/2005 7:38 PM
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Nope, intended to say interest only - zero principal. Needed coffee - sorry.

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Author: Flannagan531 Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211412 of 308858
Subject: Re: Interest Only Mortgage Date: 9/25/2005 12:44 PM
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For most people it is most appropriate to think of the primary residence as shelter only, and as a primary expense category. Don't confuse investment portfolio strategies with shelter decisions. Monetizing a home to invest is not usually an appropriate risk profile for the risk averse. Paying off a mortgage makes sense in this context.

What if you are a risk lover? If a person is ready to sell and rent in the event of financial reversals, you could come to the opposite conclusion. Remember, however, that it is quite possible for both buyer and sell to show up at a real estate closing with cashier's checks. I've actually had that experience [I was the buyer, fortunately, and the seller had lost about 120% of his equity in the house]. Having seen that first hand, I would urge any person pulling out home equity to invest to think through the worst case scenario. Know what categories are bleeding together.

The punch line: Shelter and investment portfolio should be understood separately. If you are conservative, pay off your mortgage. Safe/invest as you approach that (assuming you still have a mortgage). There's no “right” answer to the nonproductive asset/investment asset mix. It's an individual decision.

Casualty insurance is a completely different matter.




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Author: NaggingFool Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211413 of 308858
Subject: Re: Interest Only Mortgage Date: 9/25/2005 12:54 PM
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For most people it is most appropriate to think of the primary residence as shelter only, and as a primary expense category. Don't confuse investment portfolio strategies with shelter decisions.

I liked this so much I wanted to repeat and rephrase it.

For most of us, housing is about having a house to live in, not a decision about assets. Investment assets are things I can afford to lose. My house is my house; if I sold this one I would still need a place to live.

- Megan


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Author: duke345432 One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211434 of 308858
Subject: Re: Interest Only Mortgage Date: 9/25/2005 11:17 PM
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I find this amusing. Our house of 45 years has been paid for over twenty years. Our reasoning is that even though the house was paid for we still have taxes *which we just paid* that are now almost double the original payment on house including taxes of another era. What we did after paying off the note was to open a tax exempt fund and deposit the old house payment in it. When tax time rolls around each September, we write a check on this account for the amount due.

In the intervening years we have significantly increased the amount deposited each month. Among other things this now is our reserve for major expenses in the house, new car on the one payment system, and if we choose an expensive trip a way of paying cash for same.


Since the house has appreciated, we have ownership free and clear and worth something like 25 times original cost. And of course in those days gas was around a quarter a gallon.

In the intervening years we have invested a significant amount in various markets with the help of my favorite advisor. I see him in the mirror each morning as I brush my teeth. I got one bit of superb advice from one of the first brokers I dealt with. He said to buy for long haul. Forty years later I still have the same stock. But now it is worth triple my purchase price and the splits have multiplied by fifty times the number of shares.

The house is a real but minor part of our assets. We both have pensions that are secure and way more than Social Security. And we never ever pay tribute to the plastic cards by always paying in full each month.

By living on about 2/3 of our income we continue to add to our investments. We pay zero taxes on a significant amount as mentioned above thanks to exemption of state and federal taxes on municipal bond earnings.

Playing footsie with ones dwelling is silly.

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Author: TigerNation Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211438 of 308858
Subject: Re: Interest Only Mortgage Date: 9/26/2005 8:12 AM
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One thing that no one seems to notice is that almost every interest-only mortgage (I only say almost, because I haven't seen them all--but I'd bet it's true for them all) is a NEGATIVE-AMORTIZATION product! This means that the uncollected portion of the actual interest rate that the finance company is paying for the money that you're borrowing is tacked on to the principal balance. Basically this means that the bank is your partner in the growth of equity in your property, but without any risk to their capital whatsoever. The risk of the marketplace is ALL yours, they just share in the growth and get paid for it along the way. Open your eyes, people. There's no such thing as free money...unless you're the government and you own the presses and the distribution network--and even THAT's an illusion, as we know.

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Author: Sparohok Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211452 of 308858
Subject: Re: Interest Only Mortgage Date: 9/26/2005 1:25 PM
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I reviewed this thread with quite a bit of interest. (heh.) I think y'all are going off the deep end with the criticism of the investment advisor. He may or may not be an idiot, but I can certainly think of good reasons to follow this advice. And most of the critiques in this thread do not hold water.

Several posters point out that the buyer could end up underwater and have to pay money to sell the house. This is true with ANY mortgage! The only difference is whether the money comes from your paid-in home equity or from your other investments. A loss is a loss is a loss. If you truly follow this advice and carefully invest the capital you have freed up, rather than just spending it all, you should have cash to cover the difference.

In the long run, residential real estate barely tops inflation, historically speaking. Almost any alternative investment is a better bet.

Any mortgage contains an implicit call option covering the balance on the mortgage. In the case of an interest-only mortgage, the balance is the entire value of the house. You can always walk away from the mortgage if your home loses value, and the bank can't come after your other assets, only your credit rating. On the other hand, if your house gains value you can sell it and monetize the gain. For this reason, I think interest-only mortgages represent a huge liability for lenders that may or may not be sufficiently appreciated.

Finally, don't forget that only the interest payments on a house are tax deductible. The more principal you pay down the less you can take advantage of this incredible tax benefit.

The way I think about an interest-only mortgage is as a combination of financial instruments. First of all, you are renting the home from the bank. Second, you hold a rolling futures contract on the value of the house. (In other words you are exposed to the asset price of the house without having any capital invested.) This futures contract can be converted to a call option at the cost of your credit rating.

That leads naturally to the decision criteria for entering such a transaction:

1) You've done the math and it really is a lot cheaper than renting, even in a forseeable higher interest rate environment. (Don't forget all the hidden costs of home ownership, the cost of refinancing, as well as the tax deduction on interest.)

AND EITHER:

2a) The risk of the home price exposure is acceptable to your portfolio.

OR:

2b) You are willing to sacrifice your credit in the event of a major drop in real estate prices.

I've done the math and where I live (California) rent is so low relative to house prices that this does not make sense unless you place almost no value on your credit rating. In other areas and for people in different circumstances it could make a lot more sense.

Martin


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Author: CarrieMike Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211496 of 308858
Subject: Re: Interest Only Mortgage Date: 9/26/2005 11:40 PM
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You house should appreciate more than 6% a year. I have tripled my investment as the home values here have continued up since I bought in 1989. A $200K home is now over $800K. That is the best growth I know about. And all along we've been living here. Now it is time to pay off the mortgage and relax. With an interest-only loan, you can never do that.

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Author: snie Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211497 of 308858
Subject: Re: Interest Only Mortgage Date: 9/27/2005 1:02 AM
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You house should appreciate more than 6% a year. I have tripled my investment as the home values here have continued up since I bought in 1989. A $200K home is now over $800K. That is the best growth I know about. And all along we've been living here. Now it is time to pay off the mortgage and relax. With an interest-only loan, you can never do that.

CarrieMike,
I'd wager a guess that not all housing markets are like California. And, it would be Foolish to bank your assets on assuming that the rocketing housing market is going to continue ad infinitum.

Snie


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Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211514 of 308858
Subject: Re: Interest Only Mortgage Date: 9/27/2005 9:14 AM
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You house should appreciate more than 6% a year. I have tripled my investment as the home values here have continued up since I bought in 1989. A $200K home is now over $800K. That is the best growth I know about. And all along we've been living here. Now it is time to pay off the mortgage and relax. With an interest-only loan, you can never do that.

For someone who has been in the housing market that long, I am surprised that you do not remember all the ups and downs in various parts of the country, even if it has not affected you.

We bought a house in 1982, and by 1986, it was worth 4 times what we had paid for it. We sold that house in 1998, but at the time, it was worth the same as it had been in 1986. So the net effect was something like a 5% rate of return over that period time.

We bought another house in 1987 which turned out to be the peak of the market. We sold that house in 1999 for about $5k less than we had paid, and we only did that well because we were able to live through the dive and then the rebound. My neighbor also bought in 1987, but they both got laid off in the same week from 2 different companies in 1991 [that was the time of some serious lay-offs in the Boston area and around the country], and they had to sell their house for 25% less than what they had paid for it. That wiped out all their equity and they defaulted on their 2nd mortgage, so they effectively had to start over. They were not alone in this, especially in that timeframe.

There are no sure things, especially in finance and investments. Your house is the roof over your head, and if it happens to appreciate, that's wonderful. But it should not be viewed as guaranteed. Lots of things can and do happen that force people to lose money when they sell a house.

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Author: SeattlePioneer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211521 of 308858
Subject: Re: Interest Only Mortgage Date: 9/27/2005 10:26 AM
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<<Several posters point out that the buyer could end up underwater and have to pay money to sell the house. This is true with ANY mortgage! The only difference is whether the money comes from your paid-in home equity or from your other investments. A loss is a loss is a loss. If you truly follow this advice and carefully invest the capital you have freed up, rather than just spending it all, you should have cash to cover the difference.

In the long run, residential real estate barely tops inflation, historically speaking. Almost any alternative investment is a better bet.
>>


There are risks and possible rewards with any investment. One good strategy is to diversify the kinds of investments you have, which tends to spread the risk and may spread the rewards as well.

Concentrating all your investments in stocks concrentrates your risks in one kind of investment. Spreading the risks between stocks, bonds and real estate might well be a good strategy for a more people than a stocks only plan, in my view.

You seem to suggest that it is easy for people to walk away from an underwater home investment. In fact, it can be depended upon to wreck people's credit for years and may result in a deficiency judgement people may have to pay.

And stocks have a lot of volatility historically.

Personally, I began investing heavily in stocks in 1999, and despised buying real estate until I bought a home and rental real estate in the mid 1980s. I think there are often good arguments for buying both.

But the idea of a financial adviser recommending that people repeatedly refinance their home in order to maximize investments in real estate would involve excessive degrees of risk for most people, in my view. There may be times when taking risks is worthwhile, but a person who is constantly exposing themselves to high degrees of risk is inviting a financial meltdown at some time.

In short, I continue to regard the advice given the original poster to be dubious, at best.


You may well be correct that California home prices are unrealistic and to be avoided at this time, and that may be true in other parts of the country as well. Those are opinions people should consider before buying, and it may be that when such opinions are considered, buying stocks has greater appeal.

For myself, I find stock prices rather high right now as well. I'm considering selling off some of my oil and gas and other stocks that are at high levels, and may find it worthwhile to simply hold money market funds for a while.




Seattle Pioneer

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Author: synchronicity Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211552 of 308858
Subject: Re: Interest Only Mortgage Date: 9/27/2005 1:16 PM
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You house should appreciate more than 6% a year. I have tripled my investment as the home values here have continued up since I bought in 1989. A $200K home is now over $800K.

I see you live in California. To put it mildly, the recent market for housing in most of California is far from "typical"

For a much better idea about ranges of home price appreciation, check out the data at: http://www.freddiemac.com/finance/cmhpi/ For the US as a whole, home prices have appreciated at an annualized rate of 6.1% since 1st quarter of 1970. FWIW, during the same period, inflation (as measured by the CPI) has increased at an annualized rate of 4.7% (remember that this period includes the high inflation rate of the 70's and early 80's).

By contrast, this millennium (doesn't that sound so much cooler than 'this decade'?) home prices across the US have increased at a rate of 9% per year, in a much lower inflation environment (3.2% per year). And California has been something short of insane; during the same time frame, LA area housing prices have increased, on average at an annualized rate of 20% per year!!! That is, to put it mildly, not sustainable.

A real rate of return on housing of 2-3% above inflation is probably realistic for the long term. But again, housing appreciation is not the issue here. The main issue is the effective interest rate on one's loan (and any uncertaintly with that rate) compared to the expected rate of return on an alternate investment, along with one's general tolerance for leverage.

-synchronicity

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Author: Sparohok Three stars, 500 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211553 of 308858
Subject: Re: Interest Only Mortgage Date: 9/27/2005 1:52 PM
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But the idea of a financial adviser recommending that people repeatedly refinance their home in order to maximize investments in real estate would involve excessive degrees of risk for most people, in my view.

This is what you and most of the other posters in this thread fail to understand. The financial advisor is not recommending that their clients maximize their investment in real estate. The person who buys a house in cash has the same real estate exposure as the person who gets an interest-only mortgage and never pays off the principal. Instead, this advisor is recommending that their clients diversify into other investments. The risky thing about their advice is the high level of leverage. The sane thing about their advice is the much high level of diversification.

And, if you're going to take on a high degree of leverage there is no better way to do it than with an implicit call option like an interest only mortgage carries. If you get a "margin call" as the house loses value you can just walk away from the house and only lose your credit rating.

You seem to suggest that it is easy for people to walk away from an underwater home investment. In fact, it can be depended upon to wreck people's credit for years and may result in a deficiency judgement people may have to pay.

In most states mortgages are secured only by the home and the lender has no recourse to any other assets of the homeowner.

Of course it would wreck your credit. That may be a small price to pay to walk away unscathed from the major real estate crisis that many forsee in the near future. It's certainly a much sweeter deal than a margin loan from your broker.

Martin


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Author: SeattlePioneer Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211589 of 308858
Subject: Re: Interest Only Mortgage Date: 9/28/2005 4:09 AM
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<<Of course it would wreck your credit. That may be a small price to pay to walk away unscathed from the major real estate crisis that many forsee in the near future. It's certainly a much sweeter deal than a margin loan from your broker.

Martin
>>


In a falling market, a margin loan will be called and sold if additional cash is not very promptly supplied. That would result in the loss of the investment, but not damage your credit in most cases.

Loss of a house would result in the loss of any down payment plus damage to your credit. And your comments illustrate why state laws restricting deficiency judgements are unwise. They simply encourage people like yourself to exploit foolish laws passed by the government. In a just world, people like yourself would have your carcasses picked over by collection agencies and lawyers when you defaulted on your loans.

And of course a family that has avoided excessive leverage will very likely keep their home.


You are welcome to leverage yourself out to your eyeballs though, if you wish. Six years ago people like yourself were recommending the riskiest strategies in order to buy ever more internet and high tech stocks. Every boom has people who aren't as smart as they think they are damaged when things go south.



Seattle Pioneer




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Author: montecfo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211592 of 308858
Subject: Re: Interest Only Mortgage Date: 9/28/2005 8:24 AM
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Interesting thread. I did not read it all, but here are my observations so far.

1. The financial advisor is dangerous.
2. When you pay down your mortgage, you are not "investing in real estate". The return you get has nothing to do with home price appreciation, which is a constant for your particular home, whether you pay the mortgage down or not. Instead, the return you get is in interest rate savings.
3. Someone pointed out that a 6% mortgage is only 4% after taxes which is a more reasonable rate to try and beat. I would disagree. First, it is not clear the tax benefit the poster would get from the mortgage, as this requires info not provided. Further, 2% savings (33% tax rate, with all interest at the margin) would be about the best case. Lastly and most importantly, investments will liekely be taxed as well, so if you quote the interest savings after tax, those must be compared to after tax investment returns. 6% pretax is no slam dunk, and risk of loss far higher when you are leveraged.
4. Borrowing to invest in stock is a strategy only appropriate for very seasoned investors with substantial liquid assets. To put it differently, it is appropriate for very very few people.

We discuss issues such as this all the time on the Buying or Selling a Home Board. If you are interested, that is a great resource.

Best,

Montecfo

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Author: synchronicity Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211594 of 308858
Subject: Re: Interest Only Mortgage Date: 9/28/2005 9:15 AM
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3. Someone pointed out that a 6% mortgage is only 4% after taxes which is a more reasonable rate to try and beat. I would disagree. First, it is not clear the tax benefit the poster would get from the mortgage, as this requires info not provided. Further, 2% savings (33% tax rate, with all interest at the margin) would be about the best case. Lastly and most importantly, investments will liekely be taxed as well, so if you quote the interest savings after tax, those must be compared to after tax investment returns.

That was probably me, and although your points are valid (I mainly used a 33% rate to get round numbers of 6% and 4%), I think you are overstating the problem.

A) First, many people have top marginal tax rates higher than 33%. Federal tax rates max out at 35%, with the second highest rate being 33%. Second, many states have income tax rates over 5%, and the top marginal rate for many states is at a far lower income level than the feds top rate. (IIRC, California's 9.3% rate kicks in at something like 35-40K income). Although state income taxes are deductible as well, even taking this into account it is not that difficult to have a top marginal rate of 33%.

B) regarding the deductibility of interest, the situation being discussed was a purchase mortgage, and later rate and term refis. In almost all situations this interest would be deductible, barring any AMT issues. As for AMT generally only kicks in if one's itemized deductions are high relative to one's income. Granted, with higher home prices and the lack of an inflation adjustment on AMT it is impacting an increasing number of people, but it's still the exception to the norm.

C) As for investments being taxed, if one is investing in a broad based equity index fund, the majority of gains will be appreciation rather than taxable dividends. Index funds have relatively few transations and therefore are quite tax-efficient, with only limited amounts of cap gains recognized every year. Of course there would be a tax hit when one sells the fund, but that would be LTCG taxed at a 15% rate at time of sale. Obviously, the longer one can hold such a fund, the greater the benefits of the tax deferral on the appreciation.

Having said that, I agree (as should have been clear from my post) that essentially leveraging oneself in the hopes of earning greater than even a "low" 4% after tax rate of return is a highly agressive (aka "risky") strategy that is only appropriate for a distinct minority of investors, and those investors are likely well-versed enough in the potential risks and rewards that they wouldn't be getting most of their info on it from a "financial planner".

As a sidenote, when I was first purchasing my home last year, one of the products suggested by the mortgage broker was a mortgage, ARM tied to LIBOR, that had some "payment options". One of those was "interest only", the other was a regular amortized loan but you could lock in your initial payment amount for the next five years. Of course, the underlying interest rate would still fluctuate. The broker insisted to me "it's not a neg-am!" I said "well yeah, not now, but if LIBOR goes up another 75 basis points (or something like that, this is from memory), then it would become a neg-am. She didn't seem to get this concept.

And of course, LIBOR is one of the quickest rates to adjust that there is, we were near historic lows and likely to be in an increasing rate environment, and sure enough, when I checked several months later, LIBOR had increased something like 125 basis points, which meant that that option would have become a very nasty neg-am.

Her response "well, most of the traders I work with are doing this", inspired my response "I'm sure they do, 'cause they probably have enough cash that they don't need a mortgage, and are just trying to play the spread. Sadly, that's not me."

-synchronicity

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Author: montecfo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211615 of 308858
Subject: Re: Interest Only Mortgage Date: 9/28/2005 12:39 PM
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3. Someone pointed out that a 6% mortgage is only 4% after taxes which is a more reasonable rate to try and beat. I would disagree. First, it is not clear the tax benefit the poster would get from the mortgage, as this requires info not provided. Further, 2% savings (33% tax rate, with all interest at the margin) would be about the best case. Lastly and most importantly, investments will liekely be taxed as well, so if you quote the interest savings after tax, those must be compared to after tax investment returns.

That was probably me, and although your points are valid (I mainly used a 33% rate to get round numbers of 6% and 4%), I think you are overstating the problem.

It is possible to get a higher rate, sure. The larger point is that with standard deductions as high as they are now, a significant portion of the tax "benefit" of itemizing may be offset. Bottom line is you have to do the math with and without.

B) regarding the deductibility of interest, the situation being discussed was a purchase mortgage, and later rate and term refis. In almost all situations this interest would be deductible, barring any AMT issues. As for AMT generally only kicks in if one's itemized deductions are high relative to one's income. Granted, with higher home prices and the lack of an inflation adjustment on AMT it is impacting an increasing number of people, but it's still the exception to the norm.

No, the point I was making was more the question of tax benefit, not AMT. Low interest rates and high standard deduction raise the question of tax benefit.

C) As for investments being taxed, if one is investing in a broad based equity index fund, the majority of gains will be appreciation rather than taxable dividends. Index funds have relatively few transations and therefore are quite tax-efficient, with only limited amounts of cap gains recognized every year. Of course there would be a tax hit when one sells the fund, but that would be LTCG taxed at a 15% rate at time of sale. Obviously, the longer one can hold such a fund, the greater the benefits of the tax deferral on the appreciation.

Sure. But these are all assumptions, not givens. If you assume high tax benefit on mortgage interest and low tax on investments, it helps the case.

Having said that, I agree (as should have been clear from my post) that essentially leveraging oneself in the hopes of earning greater than even a "low" 4% after tax rate of return is a highly agressive (aka "risky") strategy that is only appropriate for a distinct minority of investors, and those investors are likely well-versed enough in the potential risks and rewards that they wouldn't be getting most of their info on it from a "financial planner".

We agree on this certainly. To put it differently, if you need to ask someone if such a strategy makes sense, then it very likely does not make sense for you.

Good comments.

Montecfo

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Author: GentlemanBandit Big gold star, 5000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211635 of 308858
Subject: Re: Interest Only Mortgage Date: 9/28/2005 10:52 PM
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Anyway, I'm not sold on this proposition, but need to hear from anyone if this is a strategy that is worth looking into further. - jkrihak

Here's a good article I found on MSN Money about a week ago regarding interest-only loans. I was a bit concerned that I might've made a mistake when I took mine out. Alas, this article set me straight and I'm confident I made the right decision.

http://tinyurl.com/dmkyq

Essentially the article explains the history of this type of loan and it's re-emergence in the last few years. It also lays out the pros and cons of taking out such a loan. If you're a "budget-hawk" and you've got a very good handle on your financial situation, then it might be worth some further consideration.

I do have a five-year fixed, interest-only first mortgage and an variable interest-only second mortgage that I've been in for a year. What makes it work for me is that I take the principal I would've paid on my first mortgage and apply it (and then some) to my second. I like being able to control how things get paid and know I can do a better job than any bank around.

In any event, I wish you the best of luck in making up your mind...

g!

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Author: montecfo Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211642 of 308858
Subject: Re: Interest Only Mortgage Date: 9/29/2005 9:08 AM
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Essentially the article explains the history of this type of loan and it's re-emergence in the last few years. It also lays out the pros and cons of taking out such a loan. If you're a "budget-hawk" and you've got a very good handle on your financial situation, then it might be worth some further consideration.

I agree. I do not find I/O mortgages to be right for most people, but for financially sophisticated folks with signtificant net worth, I think they can make sense. However, I would not pay a higher interest rate in order to get this feature.

Best,

Montecfo


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Author: Catleen Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 211649 of 308858
Subject: Re: Interest Only Mortgage Date: 9/29/2005 10:17 AM
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Gee, thanks for this article.

I happen to have an interest only arm and it has worked out for me. I pay extra on principle when I have the money and don't pay when things are tight. They just re-evaluated my mortgage (at 5 year mark) and I paid so much in principle that my interest only portion is $75 less then it had been previously. And I still save money every month as well.

I didn't realize this type of loan was available in the 1920s, and I didn't realize the types of changes it had undergone. When I bought 5 years ago, I was told it was a new type of mortgage loan and no one had ever heard of it (that is, none of my friends). The loan officer was very honest and stressed that I needed to make extra principle payments when I could.

I am very happy with my interest only loan, but I do realize that a less organized person might have problems with it.

Catleen

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