Interest-Only Mortgage a Stepping Stone to Retirement?

May 3, 2004 �Does it make sense to use an interest-only loan to buy the home of our dreams? We feel that is the only way we will be able to afford it. We are near retirement age and will have significant equity in the house, but our income isn�t large enough to afford more than the interest payment. I feel that in case of an emergency, we could apply for a reverse mortgage.�  It does make sense, but the reverse mortgage should be made an explicit part of your plan, not just an emergency backup. You can�t make interest-only (IO) payments forever, so you want to pay off the loan with proceeds from a reverse mortgage before the IO period ends. As far as I know, the longest interest-only period available today is 10 years. If you take a 30-year loan that is IO for 10 years, in month 121 your payment will rise to become fully-amortizing. The new payment will have to be large enough to pay off the loan over the next 20 years. That should not be a problem if you and your spouse are older than 52 now and have significant equity in the house. You will become eligible for a reverse mortgage at 62, before your mortgage payment increases. You pay off the loan with the proceeds of a reverse mortgage, and hopefully have enough equity left over to do some traveling or send a grandkid to college. WARNING: Most IOs today are adjustable rate, which involves the risk that the payment may increase markedly well before the IO period is over. You are not in a position to take this risk, which means you must have a fixed-rate IO. Copyright Jack Guttentag 2004

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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