Homes in California are expensive.
Ask anyone who has gone through the real estate process and you’ll hear stories of rapids sales, cut-throat competition, and buying opportunities disappearing in an instant. While the market has cooled and prices have dipped slightly, the typical home in California is still more expensive than almost any other area of the country.
An interest-only mortgage could provide a solution to this problem. These mortgages let you have a smaller payment at the beginning of your loan, which, for the first five to ten years, could make your cost-of-living more affordable.
An Interest-Only Mortgage in a California Market
What is an Interest-Only Mortgage?
An interest-only mortgage is simply a type of home financing that allows you to pay only the interest for a certain period. This makes them more affordable at the beginning and can help many buyers afford a home that may otherwise be out of reach.
They are usually structured with two phases. The first phase is the period when you pay only the interest. This phase usually lasts from five to ten years. The second period is when you pay down the principle on the loan. Depending on the structure of your financing, this phase can last anywhere from 10 to 25 years in most cases.
There are also two varieties of interest-only loans. You can choose a fixed-rate or an adjustable-rate mortgage as an interest-only loan. Fixed-rate options are rare, but you can find them from certain lenders; usually these loans are structured as adjustable-rate mortgages.
Here’s an example of how it might work. Suppose you have a 30-year interest-only mortgage on a $500,000 home. The initial interest-only term is ten years. For this ten year period, you make a monthly payment that is far smaller than the payment would be if you used a typical mortgage. After the initial interest-only period, you would begin to pay a larger amount. In the 11th year of the loan, the principle would begin to amortize. Now the payment would be (most likely) larger than the amount you would have if you used a typical mortgage, as you are paying off the loan in a shorter time.
Details aside, with an interest-only mortgage you basically have a period with a lower payment than usual, then you have a period with a higher payment than usual. The difference between the first and second periods can be massive, as much as $1,500 upwards of $3,000 or more, but this depends on the size of the loan, the length of the interest-only period, the interest rate, and many other factors.
These loans have a few important benefits. Most notably, they create a lower monthly payment during the introductory period. They can also have low interest rates if they are structured as an ARM loan.
The Current California Market
It seems that California real estate may be the perfect market for interest-only loans. While different cities and counties are seeing a different situation, most of California is experiencing rapid sales and high costs.
An article from The Los Angeles Times sums up the California situation well. This article says that while the California market has begun to calm, “the slowdown is minor.” Essentially, the market has cooled from the rapid price increases that were seen over the past year, but home values are still high. In many regions, the average or median sale price has increased anywhere from 10% to almost 20% in certain locations. As the article says, buyers should “expect slightly less pain.”
How much have prices risen? That depends on where you look, but according to Redfin, the median sale price for a home in California is now $705,000, which is a 14.6% increase over the past year. In January of 2017, the median home price in California, according to Redfin’s data, was $445,000; this price skyrocketed to $720,000 in June of this past summer.
It should be noted that this increase did not happen solely because of the COVID pandemic. Prices were increasing steadily throughout the years before 2020. However, when the pandemic hit in early spring of 2020, prices leaped upward. In January of 2020, the median price was $525; it was over $600,000 a year later and has steadily climbed to above $700,000 ever since.
Making the Connection: Why are Interest-Only Loans Useful in California?
Because homes are so expensive in California, an interest-only loan may be the best option for buyers. These loans allow for a low initial period, which may help you reach approval for a gorgeous home in a wonderful California neighborhood.
Of course, these loans have their risks, as lenders are certainly aware that some day, at some point, the interest-only period will end. Eventually, you’ll have to make the full payments. Lenders understand this, and you should too.
Interest-only loans may not be perfect for everyone, but there are many people who will benefit from this form of financing. These loans could be particularly beneficial if there is good reason to believe that you will earn a larger income in the future.
Recent college graduates, for example, could benefit from these loans. It stands to reason that when you take your first job after graduating, you won’t be earning your highest income right away. After a few years, however, you’ll start to reach your career potential; an interest-only loan could help you afford the house you desire while you steadily build your career. Once the larger payments come due, you’ll be ready to handle the larger costs.
So if you are starting your career in California, but don’t have the income to afford a quality home in a desirable area, you could use an interest-only mortgage.
Find an Affordable Interest-Only Mortgage in California
An interest-only mortgage in California could help you purchase a world-class home. Contact our staff today to learn more about this financing option!
