Mellody Hobson: Interest-Only Mortgages

June 4, 2005 -- -- What is an interest-only mortgage?

With an interest-only mortgage, monthly payments are lower because the borrower is only paying off interest, not principal during the early years of the loan.

For example, according to The Boston Globe, the median home mortgage in the Greater Boston area is around $350,000. Under a traditional 30-year fixed-rate mortgage, a homeowner pays almost $1,800 each month. With the same mortgage under an interest-only arrangement, a homebuyer can expect a monthly mortgage payment of roughly $1,350. That translates into an annual savings of $5,400. Multiply this by five or seven years and people don't want to pass this deal up.

Why are they appealing?

These loans are appealing for a number of reasons:

People are stretching just to get a home. According to The Wall Street Journal, in California, only 18 percent of households can afford to buy a median-priced house using a conventional 30-year, fixed-rate mortgage. Creative financing makes homeownership a real possibility. Interest-only loans accounted for 61 percent of the mortgages taken out in the state to buy homes in the first two months of the year, up from 2 percent in 2002.

Interest-only loans also make it easier to get a lot more house for your money.

What are the risks?

My rule of thumb is that when things seem too good to be true, they usually are. Although there are benefits to this type of financing, especially if the money saved is invested wisely, the downsides can be far greater than the potential upsides.

Mellody's quick home tips:

Comparing Mortgage Rates

Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is Good Morning America's personal finance expert. Ariel associates Matthew Yale and Aimee Daley contributed to this report.