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New Mortgage Math

Interest-Only Mortgage 'Hot Right Now'

Interest-Only Loans Open Door for More Buyers

WGN-TV Show Notes - May 12, 2004

Interest-Only Loans Start to Gain Interest

Growing Interest: Home Buyers Pursue Interest-Only Loans to Stretch Finances

Buyers Turn To Creative Financing for Homes

12 Ways to Save on Homeowners Insurance

Miracle Mortgage

Most I/O Borrowers Also Paying Part of Principle

Growing Interest: Home Buyers Pursue Interest-Only Loans to Stretch Finances

By Alan Zibel, BUSINESS WRITER
Alameda Times-Star (Alameda, CA)
June 13, 2004

http://media.mnginteractive.com

Jessie and Kareem Fawell sit in the front yard of their recently purchased home in San Leandro. Aric Crabb - Staff PhotoKAREEM FAWELL and his wife wanted to buy a nice house in a good neighborhood with a well-regarded elementary school nearby.

But with the prices of Bay Area homes continuing their persistent journey into the stratosphere, affording a monthly mortgage payment was a challenge.

Like many Bay Area homebuyers these days, Fawell, a 39-year-old computer programmer, decided to go with an "interest-only" mortgage -- a kind of loan that allows borrowers to make lower payments in the early years of a mortgage in exchange for higher ones later.

The loan allowed Fawell and his wife, Jessie Lipe, to buy a house that was more expensive than their initial $400,000 to $500,000 price range. They bought a $585,000 three-bedroom house in San Leandro in early April.

"If we didn't have the interest-only option, I would be stuck with payments that probably would be rapidly sucking our savings dry," Fawell said.

Interest-only mortgages permit homebuyers to make lower monthly payments in the early years of a mortgage in exchange for higher ones later. Borrowers lower their initial monthly bills by paying only the interest portion of the loan for a specified period of time, say 3, 5, 7 or 10 years.

During those early years, borrowers don't pay down any of the loan's outstanding principal balance. However, many such loans allow borrowers to voluntarily pay down the principal without a penalty if they choose to do so.

After the interest-only period ends, the borrower starts paying off the principal balance. When that happens, the monthly payment then rises -- sometimes dramatically -- because there is less time for the mortgage to be paid back.

Since the borrower's initial payments are so low, interest-only loans are making it possible for people in the Bay Area to buy homes they wouldn't otherwise be able to afford.

That has become difficult lately, with sales prices running around 15 percent higher than last year. The median price of houses and condominiums in the Bay Area hit a new record of $492,000 in April, the most recent month for which data is available, according to DataQuick Information Services.

The main drawback to interest-only mortgages is that borrowers are hit with a big increase in their monthly payment when the interest-only period ends -- if they don't sell their house or refinance their mortgage.

"You're going to be surprised, potentially, or even shocked, depending on the loan amount," said Sheila Burks, director of the Bay Area partnership office for mortgage giant Fannie Mae. "A lot of people are getting in just because it makes it more affordable in the early years."

Burks cautioned that all borrowers need to take the time to understand their mortgage terms. Many interest-only loans also have adjustable interest rates, which can float up or down. Often, those loans are fixed for several years before becoming adjustable. So if the fixed-rate period ends at the same time as the interest-only time, borrowers can be hit with a double-whammy of increased payments on their monthly mortgage.

Like many first-time buyers, Fawell is not making a down payment on his house, instead financing the entire transaction with two loans. He would have been able to make a 10 percent down payment, he said, but needed the money for roof repairs on his new house and a new car.

Fawell figures that his first mortgage, second mortgage, property taxes and insurance will work out to total payment of $3,100 a month. Without the interest-only mortgage, the monthly bill would be $3,600 a month or more, he said.

Fawell's wife may take some time off from work to raise their first child, born last week. Since the couple would then only have one income, an interest-only loan will allow them to have a lower monthly payment for the time being and still meet their goal of owning a house. Plus, their loan allows them to pay down the principal whenever they want without a penalty.

"If we could pay a little bit more, we will," Fawell said. "Once she goes back to work, we'll definitely be able to pay more."

Fawell's mortgage broker, John Holmgren of Oakland, said most people he sees applying for interest-only mortgages are new buyers trying to break into the market. Others want to minimize their mortgage payment so they can save up for retirement or college tuition. Some buyers, he said, want to maximize their tax advantages, since mortgage interest is tax-deductible.

With the rapid increase in Bay Area home prices, Holmgren said, many people believe that most of their built-up home equity will come from appreciation or home improvements, not built-up principal.

Buyers could experience a leveling-out -- or even a downturn -- in home prices in the short-term, especially given the likely prospect of higher interest rates in the near future. But Holmgren said that people tend to have confidence in the long-term health of the Bay Area real estate market.

"I think people do feel optimistic that real estate in the long run will appreciate," he said.

Mortgage brokers and mortgage bankers say interest-only loans mainly make sense for people who have good prospects of earning more money in the future -- such as new doctors or lawyers.

They also can make sense for people who are going to move into a new house -- or out of the Bay Area entirely -- before the interest-only period is over. And they also may make sense for couples who have one spouse taking time off from work to raise a child and then planning to start working again.

"It's the difference between buying a home and not buying a home for many people," said Brad Blackwell, national sales manager for Wells Fargo Home Mortgage. "They are really a very good alternative for people who understand how they work."

Wendy Muir, Washington Mutual's regional sales manager for part of the Bay Area and Sacramento, said interest-only loans appeal to higher-income and more "financially savvy" buyers. "They should be very well aware of how to handle their finances."

Experts caution that interest-only loans carry some serious risks, especially if Bay Area home prices level off or even turn downward. In a worst-case scenario, borrowers could be stuck without enough money to pay off their mortgages. That could happen if borrowers don't pay down any of their principal balance during the interest-only period and prices don't increase much before they need to sell.

Greg McBride, a senior financial analyst at Bankrate.com, warned that an interest-only loan can put people in a "precarious position should prices undergo any type of correction."

McBride said that if borrowers have no equity in their houses when they need to sell and prices haven't increased all that much, they could actually lose money after the costs of selling are taken into account.

"You're entirely dependent upon appreciation," McBride said. "What happens if that price drops in the next couple of years?"

George Duarte, president of Horizon Financial Associates in Fremont, said interest-only loans are "something that gets the buzz at cocktail parties" but they are not a good idea for people who are looking to build a lot of equity in their homes before they retire.

In the Bay Area, the idea that home prices could decline or stay flat may seem unlikely, given the 7 to 10 percent annual appreciation that has been common in recent years. But with interest rates on the rise, some experts warn that the Bay Area housing market could cool off.

Many people in the Bay Area have started to view their home as an investment whose value is certain to increase year after year, Duarte said.

"People think that the market is always rising and that it will never, ever correct or fall or be flat," Duarte said. "If people buy a piece of property expecting a certain return ... they may be very disappointed."

Some people who use interest-only mortgages could afford to buy a home with a more traditional loan, but instead use the interest-only mortgage as a money-management tool.

One of those people is Keiron McCammon, vice president and chief technology officer of software company Versant Corp. of Fremont. He said he used an interest-only loan to refinance the mortgage on his Danville home last year.

McCammon, 33, has a mortgage from Wells Fargo that effectively functions like a bank account. It allows him to pay down the principal balance on his home if he wants to, but also pull out money through a home equity line of credit if need be.

McCammon said that using his spare cash to bring down the principal balance of his mortgage made more sense than having his money sit in a savings account. He has been making principal payments on his mortgage, not just paying the interest, he said.

"It's worked very well for me," McCammon said. "I've made a substantial payment against the principal, which is the cash I had sitting around doing nothing."

Some real estate investors also are jumping on the bandwagon and making use of interest-only loans.

Blake Huntsman, 43, of Oakland, an environmental inspector for Alameda County, has been a real estate investor for the past six years, buying rental properties in the Bay Area and Central Valley.

Huntsman said he has gradually moved his properties over to interest-only mortgages. He figures he will be able to save $25,000 to $30,000 over five years for each property by doing so.

Huntsman said he can use the money that he saves for maintenance or to offset losses until each property is filled with tenants.

"It's a great tool, especially in this area," he said. "It's allowing people to get the house they want and it's allowing them to qualify for it."

California Refinance Of Foster Home With Pay Option Mortgage-

Pay Option Mortgage loan proved to be the ideal solution for the refinance of a Foster Home in Southern California by substantially reducing monthly payment.

/24-7PressRelease/ - Alta Loma, CA, June 05, 2005 - "We recently received an application from Angela P. who needed to refinance her California home. While finding out her specific goals for the refinance I learned that she was a foster mom and cared for multiple "crack" babies that had been taken away from their mothers at birth because of testing positive for an illegal substance during labor," states Gary Rees.

"She was trying to utilize the equity in her home to remodel and add a bedroom to make it more comfortable for the two teenage and two newborn children her and her husband care for."

"For their situation I decided that a Pay Option mortgage loan program would give them the cash flow needed to cover shortfalls. It also lowered their mortgage payment over 1500 a month," continues Rees.

A Pay Option Mortgage Loan allows the complete flexibility to decide, every month, which of four mortgage payments you would like to make.

This program is ideal for anybody that has fluctuating income such as the self-employed. Pay Option is also an excellent choice if you are looking to buy a new home and want the lowest possible monthly payment, or if you simply just want to lower your existing mortgage payment.

The Pay Option Mortgage is a relatively new product that allows you four payment options each month.

1. 15 year payment- Pay your loan off and build equity faster as well as save thousands of dollars in interest

2. 30 year payment- This option will let you know how much to pay to have your home free and clear in the standard thirty years

3. Interest only option- This option allows you to pay only the interest portion of your monthly payment so you can increase monthly cash flow

4. 1% Minimum payment-This option allows you to pay your mortgage at a 1% rate of interest for maximum savings

The Pay Option Mortgage is the absolute best adjustable mortgage product available today. It has built in features that protect you from the typical worries associated with an adjustable rate mortgage.

One is the fact that your payment cannot increase more than 7.5% above the previous year for the first five years. Another gives you the option to convert to a fixed rate mortgage after the first three years. With these features in place you can rest easy with your new adjustable mortgage.

Here is an example of what a Pay Option Mortgage could for you

Estimated Current Monthly Payment - $1663.26
New first year payment - $833.13
Estimated increased monthly cash flow- $830.13
Estimated increased yearly cash flow - $9961.52

Disclaimer-First years interest rate 1.25%. Interest charged at 3.45% for the first month. APR 3.74% subject to increase monthly. 30-year loan.

This loan may have negative amortization. Max increase/decrease in monthly payment is 7.5% per annum for the first five years. This is an ARM product.
Example payments based on 7.0% interest rate and $250000 loan.

"During the loan process I got a chance to visit her home and was really impressed by the cleanliness of both her home and all the kids. I have three of my own and I can tell you it's a challenge to keep up the house and the kids and the homework."

"Clearly a great family! We decided to waive our fees and pick up the costs involved in this transaction for Mr. and Mrs. P who are providing love and shelter to the innocent children victimized by addiction."

"It was the least we could do for this amazing family that breaks even after buying clothes and food for the kids. For Angela and her husband, this is truly a labor of love!" concludes Rees.

Buyers Turn To Creative Financing for Homes

By Mike Freeman
STAFF WRITER
July 18, 2004

In May, when Patrick Higle and his fiancee purchased a $520,000 house in Rancho Peñasquitos, they didn't get a 30-year fixed-rate mortgage or even a traditional adjustable-rate loan.

Instead, they chose a hybrid adjustable mortgage that allowed them to borrow nearly the full price of the home, and pay only the interest on the loan for the first two years.

"It was the only program where we could get the type of house we wanted in the location we wanted with no money down," said Higle, 33, a first-time home buyer.

Once available as financing vehicles only for wealthy, sophisticated borrowers, interest-only loans, no-down-payment mortgages and a host of other creative financing packages have come into the mainstream for home buyers in San Diego County and in other regions where prices have skyrocketed.

Some in the mortgage industry say the increased popularity of creative mortgages has contributed to soaring home prices by allowing buyers to qualify for larger loans.

While these loans make sense for many borrowers - those who are going to sell their homes within two or three years or those who expect their incomes to increase - they tend to be riskier than traditional fixed-rate mortgages.

If home values stall, these borrowers won't build much, if any, equity in their homes.

Many of the popular interest-only loans are one flavor or another of adjustable-rate mortgages. Because they are adjustable, these loans initially have lower interest rates, meaning borrowers have lower monthly payments.

They work well for borrowers when interest rates are declining. But when they rise, borrowers can expect increases in their monthly payments.

In May, 72 percent of homes in San Diego County were bought with adjustable-rate loans, up from 45 percent in May 2003, according to DataQuick Information Services of La Jolla. In addition, 23 percent of May mortgage deeds showed no-down loans or 100 percent financing, up from 16 percent a year earlier, DataQuick said.

"Back in 2000, there was basically one lender that offered 100 percent financing," said Scott Harmes, branch manager with 100PercentHomeLoan.com in San Diego. "Today, there are 43 that provide 100 percent financing."

Soaring home prices have forced many buyers to take unconventional loans. In the past three years, the median price of resale houses in San Diego County has risen to $520,000 from $330,000, a 58 percent gain.

Incomes haven't increased nearly as fast. The result is that more homes would be out of reach for more buyers if not for the new financing plans.

"What people are paying attention to is the monthly payment," said Anna Cotton of LoanCor Inc., a mortgage broker in Carlsbad. "They're so frenzied to get into the market" because they are fearful that the opportunity to buy a house is going to slip away with rising interest rates.

Betting on equity
One of the more aggressive mortgage programs is the Option ARM, or negative amortization, loan. These loans typically carry a very low rate for the first year.

For borrowers, that's the lure.

With Option ARM loans, the borrower pays only part of what's owed early on in the life of the loan, including interest. The unpaid interest is added to the loan's balance. That creates "negative amortization, meaning homeowners end up owing more than they originally borrowed.

These loans also tend to have broader limits on how often the interest rate can adjust. That means the rate could rise every month instead of every six or 12 months in traditional adjustable-rate mortgages.

With these loans, borrowers bet that the increasing value of their home will eclipse their negative amortization.

"Typically, people in this market are buying to build equity," Harmes said. "The target is a two-year time frame. So we try to put them in loans that are the lowest possible (payment) for two years. At that point, they've built equity, they have a history of making house payments and we can roll them into long-term financing."

Experts warn that negative amortization loans, interest-only loans and 100 percent mortgages could spell trouble if the market flattens.

"I'm not a big fan of debt, and if you do one of these 100 percent loans, you're taking a great deal of risk," said Dale Yahnke, a money manager with San Diego's Dowling & Yahnke, an investment advisory firm.

A recent study by the Federal Reserve Board found that if interest rates rise, existing-home prices nationally would increase 2.6 percent in the next three years.

That would mark the lowest rate since the government began keeping records in 1970. The number implies that, in inflation-adjusted terms, housing prices are likely to decline.

The benefits
Moorhouse and others in the mortgage industry say interest-only loans aren't necessarily bad. Depending on who is doing the calculating, the average life of a mortgage in California is roughly three years. After that, borrowers either sell or refinance.

So if buyers are going to be in a home for a short time, using interest-only loans gives them greater cash flow and more flexibility, mortgage lenders say.

When Eric and Heidi Kendall purchased a $351,000 bungalow in University Heights in May 2003, they decided on an interest-only loan for the first five years.

That gave them a monthly mortgage payment of about $1,000.

"In the first three years, you're not going to pay down much principal anyway," Eric Kendall said. "If we were going to stay here awhile, we would have done conventional financing."

Already, the couple are moving on, buying a new $450,000 condominium in Mission Valley. They are using an interest-only loan again - but this time with a seven-year fixed-rate period.

Eventually, the Kendalls hope to afford a larger house.

"Interest-only allows you to make incremental steps to get to where you want to be," Eric Kendall said.

More and more San Diego County home buyers these days agree.

"Clients are getting more sophisticated," said James Endicott, who runs his own mortgage broker business. "The biggest mistake people have made in real estate finance over the past 20 years is always going for 30-year, fixed-rate loans."

Even if interest rates rise, Endicott said, most borrowers will be able to handle it.

"For many, many buyers, interest-only makes so much sense because you have the value of that asset at a much lower price," he said. "And certainly in Southern California, we anticipate appreciation."

Others warn that housing prices run in cycles. Interest-only payments might be fine for borrowers who didn't stretch too far to get into a home. But if they took on all the debt they could handle, they are asking for trouble.

"I personally think the lenders are crazy and the borrowers are crazy because there's no wiggle room for the potential that the markets will not go up," said Elaine Worzala, a real estate professor at the University of San Diego. "Some people could get themselves into some pretty bad situations."

Higle, who bought the home in Rancho Peñasquitos, knows that his two-year hybrid adjustable-rate mortgage is riskier than a 30-year, fixed-rate mortgage.

"It's a crap shoot," he said. "In two years, when we have to refinance, where will interest rates be? Hopefully by then, we'll be making a little more money, and we'll have some equity built up in the house."

Besides, he added, "I don't think home prices are going to go down in the San Diego area."

12 Ways to Save on Homeowners Insurance

SHOP AROUND
Friends, family, the phone book and Internet are some of the sources you can use to find homeowners insurers. Get a wide range of prices from several companies. But don't consider price alone. The insurer you select should offer both a fair price and excellent service. Quality service may cost a bit more, but you buy insurance in case you need to make a claim, so it's important to get a company with a good reputation. Talk to a number of insurers to get a feeling for the type of service they give. Ask them what they would do to lower your costs. Check the financial ratings of the companies with AM Best or Standard and Poor's.

RAISE YOUR DEDUCTIBLE
Deductibles are the amount of money you have to pay toward a loss before your insurance company starts to pay. Deductibles on homeowners policies typically start at $250. Increase your deductible to
$ 500 -- save up to 12 percent
$1,000 -- save up to 24 percent
$2,500 -- save up to 30 percent
$5,000 -- save up to 37 percent

BUY YOUR HOME AND AUTO POLICIES FROM THE SAME INSURER
Some companies that sell homeowners, auto and liability coverage will take 5 to 15 percent off your premium if you buy two or more policies from them.

WHEN YOU BUY A HOME...
Consider how much insuring it will cost. A new home's electrical, heating and plumbing systems and overall structure are likely to be in better shape than those of an older house. Insurers may offer you a discount of 8 to 15 percent if your house is new. Check the home's construction: In the East brick is better, because of its resistance to wind damage, and in the West frame is better, because of its resistance to earthquake damage. Choosing wisely could cut your premium by 5 to 15 percent. Avoiding areas that are prone to floods can save you about $400 a year for flood insurance. Homeowners insurance does not cover flood-related damage. The closer your house is to firefighters and their equipment, the lower your premium will be.

INSURE YOUR HOUSE, NOT THE LAND
The land under your house isn't at risk from theft, windstorm, fire and the other perils covered in your homeowners policy. So don't include its value in deciding how much homeowners insurance to buy. If you do, you'll pay a higher premium than you should.

IMPROVE YOUR HOME SECURITY AND SAFETY.
You can usually get discounts of at least 5 percent for a smoke detector, burglar alarm, or dead-bolt locks. Some companies offer to cut your premium by as much as 15 or 20 percent if you install a sophisticated sprinkler system and a fire and burglar alarm that rings at the police station or other monitoring facility. These systems aren't cheap and not every system qualifies for the discount. Before you buy such a system, find out what kind your insurer recommends and how much the device would cost and how much you'd save on premiums.

STOP SMOKING
Smoking accounts for more than 23,000 residential fires a year. That's why some insurers offer to reduce premiums if all the residents in a house don't smoke.

SEEK OUT DISCOUNTS FOR SENIORS
Retired people stay at home more and spot fires sooner than working people and have more time for maintaining their homes. If you're at least 55 years old and retired, you may qualify for a discount of up to 10 percent at some companies.

SEE IF YOU CAN GET GROUP COVERAGE Alumni and business associations often work out an insurance package with an insurance company, which includes a discount for association members. Ask your association's director if an insurer is offering a discount on homeowners insurance to you and your fellow graduates or colleagues.

STAY WITH AN INSURER... If you've kept your coverage with a company for several years, you may receive special consideration. Several insurers will reduce their premiums by 5 percent if you stay with them for 3 to 5 years; by 10 percent if you remain a policyholder for 6 years or more.

COMPARE THE LIMITS IN YOUR POLICY TO THE VALUE OF YOUR POSSESSIONS AT LEAST ONCE A YEAR
You want your policy to cover any major purchases or additions to your home. But you don't want to spend money for coverage you don't need.

LOOK FOR PRIVATE INSURANCE FIRST
If you live in a high-risk area, one that is especially vulnerable to coastal storms, fires, or crime, and have been buying your homeowners insurance through a government plan, you should check with an insurance agent or company representative. You may find that there are steps you can take that would allow you to buy insurance at a lower price in the private market.

SHOP for Insurance

The miracle mortgage
How do you buy a home in a boom? The answer may be a new loan that's part blessing, part time bomb.

May 16, 2005
By Cybele Weisser, MONEY Magazine

NEW YORK (MONEY Magazine) - Six months ago, Chris and Suzanne Bernier were just getting by. The couple's debt load had grown to more than $9,000 in four years as they relied on credit cards to fund a new camper, vacations and stuff for children Eryn, 16, Dylan, 13, and C.J., 3.

Though they had already refinanced their mortgage -- to a low 5.5 percent interest rate on a 30-year fixed loan -- and consolidated their high-rate credit-card debt into a bank loan, they simply weren't getting ahead.

"We were still living month to month," says Chris, 37, a desk officer with the county sheriff's department.

But now, by paying only the interest on a 4.85 percent adjustable-rate mortgage, the Berniers have an extra $400 a month that they are using to whittle down their debt and build up their savings. And they are confident that they will be able to buy a new, larger home within five years.

"We feel like we are finally on track to getting somewhere," says Suzanne, 36, a manager at a mortgage processing company. Chris agrees. "We've chosen to use the power of the interest-only loan for our own benefit."

Growing popularity
Like the Berniers, tens of thousands of Americans have recently discovered the power of paying nothing but interest on their home loans.

The appeal is easy to understand: When you don't pay down principal, you can save hundreds, even thousands, of dollars a month. Interest-only payments let you shoulder a bigger mortgage and buy a home you might not otherwise be able to afford. Or you can use the extra cash to pay down debts or fund a child's education.

Whatever the reason, consumers are finding the lure of lower payments hard to resist. According to mortgage data firm LoanPerformance, nearly a third of home loans made last year nationwide included an interest-only option, up from almost none four years ago.

In the hottest real estate markets in the country (particularly on the coasts) lenders say that as many as 70 percent of new loans are interest-only.

The problem: Those low payments don't last. Eventually, every interest-only mortgage converts to a regular one, and unless you sell or refinance before that time is up, you'll see a steep rise in your monthly payments. And because most IO mortgages are also adjustable, that increase could be doubly harsh if rates go up.

"I think there is a day of reckoning coming for these loans in the hands of the wrong people," says Patricia Houlihan, a financial planner in Reston, Va.

Still, an interest-only mortgage can be a sensible choice at times. If you are tempted to grab one -- or already have and wonder what comes next -- read onto learn more about this hot loan.

How the loan works
What people commonly call an interest-only mortgage isn't one particular type of loan. Rather, interest-only is an option that can be attached to any mortgage.

And in every case, after a certain time (usually five, seven or 10 years) the mortgage becomes fully amortizing, and you must pay both interest and principal. Because you're repaying the principal in 20 or 25 years, not 30, those principal payments are higher than they would have been.

Other than that, the terms are as varied as those on any other mortgage -- anything from a one-month adjustable rate to a 30-year fixed. IOs generally have a slightly higher rate (about a quarter of a percentage point) than the same loan without the interest-only feature (one reason lenders like them). But for most borrowers, that's a small price to pay for the deep savings that interest-only payments represent.

What can go wrong
The biggest problem is payment shock: Someday you will have to write a check to your mortgage company that's hundreds of dollars higher.

Take a $300,000 interest-only ARM that has a fixed rate for five years and then converts to a regular one-year ARM. If the one-year rate is 6 percent (a typical rate over the past 15 years), your payment would go from $1,335 to $1,933.

Another minus is that you don't accrue any equity during the interest-only term. Yes, it's true that you pay mainly interest in the first few years of any mortgage.

On a $300,000 traditional mortgage at 6 percent, for example, only $3,684 of the $21,584 you pay in the first year goes toward principal. But that quickly adds up. You'd have built about $21,000 of equity in five years, $50,000 after 10 years.

"The attractive feature of amortization is that it's automatic and every month the savings go up," says Jack Guttentag, a Wharton professor who runs www.Mtgprofessor.com, a mortgage information Web site.

Of course, this torrid real estate market has seemingly eliminated the need to pay down equity. Many home buyers figure they can quickly reap huge equity gains simply by owning a house. An interest-only loan is a foot in the door.

But wait: There's no guarantee that home prices will keep rising; you are essentially making a bet on your local market. Remember the $21,000 in principal you paid in the first five years in the loan example above?

If you made a small down payment and housing prices stayed flat in your area during that time, that equity could make the difference between covering your closing costs and commission -- or having to bring a check to the closing to pay off your mortgage.

Who's a candidate?
Despite these cautions, interest-only mortgage payments can be a useful tool in certain situations.

You can count on a higher income in a few years. Say you're a medical resident or a young lawyer and are confident that you'll get big raises well before higher payments kick in. Or you're a stay-at-home mom who plans to return to work full time when your kid hits kindergarten. An interest-only loan can help get you into a home now that will match your paycheck down the road.

"There's no reason to put your life on hold and not move into the right home because of a temporary situation," says Ross Levin, a financial planner in Edina, Minn.

Similarly, interest-only loans can work well if you get a large year-end bonus or periodic commissions. Throughout the year your mortgage payments are low, and then you can pay off principal when the extra cash comes in. (Make sure your loan doesn't have a prepayment penalty.)

You have a good use for your monthly savings. Alternatively, you may be able to afford a regular mortgage but would rather deploy the money elsewhere.

With lower mortgage payments, you can pay down high-cost debts or meet a short-term expense such as college tuition. By saving for five months, the Berniers have already built an emergency cash reserve.

The key for this scenario to work, says Levin, is that you must have the discipline to save or invest that extra money, not just use it to fund a high-flying lifestyle. "My biggest concern is that people are well-intentioned but don't actually set aside the money," he says.

You know you are going to move or sell soon. If you don't plan to stay in your home for long -- because of a job transfer, retirement or an expanding family -- you won't build much equity anyway.

But be careful if you are stretching to buy. You may find that it is difficult or even impossible to sell your home quickly if the market sours, leaving you with a loss or the prospect of payments you can't afford.

Serious real estate investors find interest-only loans especially valuable. Low payments let them buy more properties or make more money on the rent.

"The point for me is to get in, fix it up and get out within two years," says Jay Williams, 34, a real estate investor in Atlanta who has bought three of his six properties with interest-only loans.

But Williams, who has suffered real estate losses as well as gains, is cautious.

"I only use interest-only if I'm investing in an area where I know the appreciation is strong," he says. "If I'm not sure what the market is going to do, I won't take a chance."

The exit strategy
What if you've already taken out an interest-only mortgage but don't plan to move any time soon? You need to keep in mind that higher monthly payments are inevitable, and you better have a plan. (Don't count on an easy out like low-rate refinancing; mortgage rates are near historic lows now and are more likely to be higher than lower when your interest-only term ends.)

Instead, take the time to ask yourself some questions: Where would the money for bigger mortgage payments come from? What in your budget can you cut? Would you consider selling your home if you couldn't afford it?

Alternatively, if you can write a bigger monthly check today, there is an easy out: Refinance into a fixed-rate mortgage. After all, with interest rates poised to rise, you're unlikely to find a better time to lock in.