Newfangled mortgages

From the Santa Cruz Sentinal:

Lessons on newfangled mortgages

What happens when you rent a house? You pay money month after month and never build up equity in the property. All that money gone and nothing to show for it.

What happens when you buy a house with an interest-only, no-money-down mortgage? You pay money month after month and, unless the property value increases, never build up any equity. You might even lose money.

How can this be?
…
Economically, an interest-only, no-money-down purchase closely resembles a lease with an option to buy. In both cases, the monthly payment is greater than the straight rental cost. In both cases, the price of the house is set at the time of the transaction and appreciation above that price belongs to the lessee or homebuyer. If the mortgage is fixed rate, the homebuyer gets the added benefit of immunity from increases in rent.

The main difference is the greater risk taken on in the purchase transaction. If things don’t work out — the property fails to appreciate in value, the occupant needs or wants to relocate, the house becomes too big or too small for the family — lessees can walk away without repercussions at the end of their lease.

Interest-only buyers cannot take this easy way out. To be free of the property, they must either sell the house with all the associated hassle and expense or default on their loan and return the house to the lender. Even if the lender takes the loss, the buyer’s credit will be compromised and the IRS may count any unpaid debt as taxable income. If the lender cannot be forced to take the loss, the owner may have to bring money to the closing just to get rid of the property.

The distinction between owning and leasing with an option may not matter when prices are rising sharply and houses are selling like hotcakes. But when prices are flat to down and houses stay on the market for months, an unwanted or unaffordable home is a financial and emotional millstone.

One year into a deflating real estate bubble, this is a lesson too many buyers with newfangled mortgages may learn the hard way.

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