Against the grain: Why we chose an interest-only mortgage
Brian from Financial Dominance asked an interesting question on my post about our Zero Debt Goal. He asks:
Have you written a post about why you went with the interest only mortgage? My thought was that most of the personal finance bloggers advocate fixed mortgages pretty hardcore, but you took a different route. Also it looks like you put the mortgage together about 3 years ago when rates were at all time lows, so it would have made sense to slap a fixed rate on it.
Our Situation 3 Years Ago
I’ve mentioned before that we’ve increased our income by about 40% since 3 years ago mainly due to job changes. That means three years ago, we were making much less than we are now. Also, we had about $100,000 in debt at the time. You can probably see where this is going, but there’s a little more to the story.
We liked our apartment, but near the middle of our lease, we learned that our adjoining neighbor stole our mail (and about 100 others’), committed identity theft on another neighbor, hid an old Cadillac they said was stolen (insurance fraud), and had pretty hardcore drugs in the fridge. They were arrested, but it tarnished our opinion of the little community.
By the time all the drama unfolded, it was nearing the end of our lease term, and we also found out our rent was increasing by $200 per month. That settled it. We were going to buy our first home. Without getting into the details, we found our home, met with the broker and went through our options. Due to our debt, we didn’t have much room in our budget for a high mortgage.
Basically, we had the following options for housing:
- Renew our rent for about $1,700 per month
- Find somewhere else to rent and deal with this again in a year
- Buy a pretty nice, new condo in our town center (or near it)
- Buy a 20-30 year-old, moderate sized townhouse about 10 miles from town center
- Buy a 20-30 year-old, moderate-sized single family home about 20-30 miles from town center
- Buy a 63-year-old, small single family cape cod about 1 mile from town center
All of these homes were in the $300,000 – $400,000 range. We refused to buy a condo because we both grew up in homes with large yards. If we wanted an apartment, we would just rent one, not buy it. We checked out a number of townhouses, but they were all too small and not convenient to the interstate (we both worked in Virginia at the time). Lastly, we didn’t want to deal with the homes that were too far away because we knew the commute would be horrible.
So we chose our little cape cod that’s 2 miles from the interstate and smack-dab between 2 metro stations. We could never find anything so convenient to the metro and highway, with the plot size, square footage, and price anywhere in northern Virginia. So that’s why we bought in MD, but still worked in VA.
But why did we choose the “bad loan”? You can probably guess it was because the interest-only loan had the lowest monthly payment compared to a 30-year fixed loan. For another year after closing on the loan, we couldn’t really pay much extra towards our debts or savings until I made that first job change. Then we got enough extra each month to have some breathing room.
We didn’t do one of those crazy loans though, and we didn’t overextend ourselves either. We did a simple 5/1 ARM loan, of which we still have a little over 2 months to refinance. Also, we weren’t at the peak of the low rates 3 years ago. By that point, it was still a seller’s market, but not nearly like 6-12 months prior. The fed was already increasing rates, so we locked in at 5.25%. One other impetus for buying a home was the increasing rates. We got the market fever just like everyone else, but I think we made a very fine decision in our purchase.
Lastly, we got an interest-only loan because we figured we would only keep the house for 5 years and then move on (or away). We really do like our house, so that decision in 2 years will be a hard one.
So there you have it. The reason why we got an interest-only loan when the rest of the blogger community despises anything but a standard loan is because it was affordable. We just wanted some stability in location, which is why we got out of the rental market.
Looking back though, I often wish we had thought more about just dealing with the bump in rent and staying where we were. Owning a home is expensive, even with all the tax breaks. It’s an investment, but what many finance gurus don’t calculate is the time cost of owning vs renting. I spend a lot more time on this house than I ever did in my years of renting.