Interest-only owners: "heading straight for a big wall"

As an Exotic Mortgage Resets, Payments Skyrocket

Excerpts:

Edward and Maria Moller are worried about losing their house — not now, but in 2013.

That is when the suburban San Diego schoolteachers will see their mortgage payments jump, most likely beyond their ability to pay.

Like millions of buyers during the boom, the Mollers leveraged their way into a house they could not otherwise afford by taking out a loan that required them to make only interest payments at first, putting off payments on the principal for several years.

It was a “buy now, pay later” strategy on a grand scale, meant for a market where home prices went only up, and now the bill is starting to come due.

With many of these homes under water — worth less than the loans against them — many interest-only mortgages will soon become unaffordable, as the homeowners have to actually start paying principal. Monthly payments can jump by as much as 75 percent.

The Mollers owe so much more than their house is worth, and have so few options, that they are already anticipating doom.

“I’m praying for another boom,” said Mr. Moller, 34. “Otherwise, we’ll have to walk.”

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John Karevoll, a longtime senior analyst for MDA DataQuick, sees the plight of interest-only owners this way: “You’re heading straight for a big wall and you can’t put the brakes on.”

The greater the length of the interest-only period, the more years the owners have to hope for a recovery, government help, or a miracle. But a long interest-only period works against them, too. A loan that is interest-only for its first 10 years means the entire house has to be paid off in the next 20 rather than the more typical 30 years.

One possible solution: start paying extra each month now to pay down the principal before the loans reset. But many homeowners took out the maximum they qualified for, and don’t have the means to pay more, or at least not enough to make a sizeable dent in the principal.

A decade ago, interest-only loans were rare. But as the boom heated up and desperate buyers sought any leverage they could, these loans became ubiquitous. They were especially popular in Florida, Nevada and above all California. In 2004, nearly half of all buyers in the state got one.

The Mollers bought in 2005, paying $460,000 for their three-bedroom, thousand-square-foot house. A quick refinance a few months later supplied cash to pay debts. Now the house is worth perhaps $310,000. After their interest-only period is up, they expect their monthly payments to increase 20 percent if not more.

Comment: What were these people thinking?