It's a strategy that can backfire. Dimitrios Kambouris/Getty Images Beyoncé and Jay-Z are making interest-only payments on the $52 million mortgage t
- Beyoncé and Jay-Z are making interest-only payments on the $52 million mortgage they took out on their Bel Air estate.
- Interest-only mortgage payments are lower at first, but can become unaffordable when the principal is added.
- The mortgage strategy can be used by anyone, but requires careful financial planning to minimize risk.
Even Beyoncé and Jay-Z have a mortgage.
The highest-paid celebrity couple has been on a homebuying spree lately, scooping up a secluded $26 million Hamptons mansion in addition to purchasing an $88 million Bel Air estate earlier this summer.
After putting 40% down on the Bel Air property, Beyoncé and Jay-Z are currently making interest-only payments on the remaining $52 million mortgage balance.
For the billion-dollar duo, taking out a mortgage allows them to put their cash toward other uses — which could be a smart business decision, Business Insider’s Tanza Loudenback reported.
But if you don’t have a net worth of $1.16 billion, an interest-only mortgage could be a risky move.
Interest-only mortgages become more expensive in the future
For those who are simply using an interest-only mortgage as a way to afford a bigger home, it’s a strategy that can backfire.
Brandon Turner, a real estate agent at Compass who sells million-dollar apartments in New York City, says some of his younger clients ask about interest-only mortgages because “it would give them the ability to afford a higher priced apartment, and maybe invest a bulk of money elsewhere to build some net worth,” he told Business Insider.
But Turner advises against it. “One problem with going with this mortgage option is that when the time comes that you will be paying the interest plus principal, you need to be certain you can afford this, which in turn most likely means that you will have to be certain of an income increase,” he said.
If your income doesn’t rise as expected before the higher payments kick in, you can find yourself in over your head almost overnight. Even interest-only payments can become unaffordable if interest rates increase.
Although interest-only mortgages make up a very small share of the US mortgage market, according to Svenja Gudell, chief economist of home buying site Zillow, some homebuyers are intrigued by the prospect of buying a home with low initial payments.
Securing any type of mortgage requires very good credit these days — the median credit score for mortgage borrowers was 764 in the first quarter of 2017. In the years since the financial crisis, banks have made the approval process tougher, thanks in part to the CFPB’s “ability-to-repay” rule requiring better proof that buyers can afford the payments.
In the US, interest-only mortgages played a big role in the 2008 housing crisis, as many people were hit hard by increasing interest rates and dropping home values. The mortgage product is considered “taboo” in Australia, and regulators in the UK take a hard stance against it.
Gudell agrees that interest-only mortgages are not a sustainable long-term product. “It makes you very susceptible. If the market moves you can very easily be underwater,” she said.
Interest-only mortgages may make sense in certain cases
Still, there are some instances when an interest-only mortgage makes sense, even if you’re not Beyoncé, San Francisco-based financial planner Elizabeth Revenko writes on NerdWallet. For the average person considering one of these mortgages, the key is to make sure you’ll be able to afford the full payments in the future.
If you have high annual income but variable cash flow because you’re self-employed or receive most of your compensation in bonuses, an interest-only mortgage can provide flexibility to pay down the principal on your own schedule. Same goes if most of your net worth is tied up in investments you’d rather not sell.
Or, if you plan to sell the home well before the interest-only period ends, it can help keep carrying costs low in the meantime. However, if you aren’t able to sell as planned, you’ll find yourself on the hook for higher payments when they come due.
Another option could be a low-down-payment mortgage
For some buyers, especially first-time buyers, saving up for the down payment may be a bigger hurdle to homeownership than making the monthly payments. If you have reliable income, but little in savings, you may be able to buy a home with as little as 3% down. In some cases, you can buy a home with no down payment at all.
Buying a home with 20% down and a 30-year fixed rate mortgage is ideal if you can swing it, but as home prices continue to climb, that standard isn’t always realistic. Making a smaller down payment could expedite the homeownership process for some buyers.
The bank will see you as a riskier borrower, however, so you’ll typically have to pay private mortgage insurance (PMI) until you’ve built up 20% equity in the home. For example, if your home is worth $250,000, you’ll pay PMI until your mortgage balance is $200,000 or less.
Setting a comfortable budget before getting approved for a low-down-payment mortgage can help keep costs in check. Mortgage bankers and real estate brokers are incentivized to push you to spend as much as you can possibly afford — but buying at the high end of your budget could cause financial stress later, and isn’t necessarily an investment that will pay off.
Make sure to get objective advice before buying a home
Ultimately, consulting an unbiased third-party adviser, who is not paid based on the total cost of the home, is a good idea, especially before using a less conventional mortgage product. It’s important to feel confident you can afford the payments before you sign on the dotted line.