From An Investor's Perspective
Interest-only loans are sometimes generated artificially from structured securities, particularly CMOs. A pool of securities (typically mortgages) is created, and divided into tranches. The cashflows that are received from the underlying debts are spread through the tranches according to predefined rules, an Interest-only (IO) loan is one type of tranche that can be created, it is generally created in tandem with a principal only (PO) tranche. These tranches will cater to two particular types of investors, depending on whether the investors are trying to increase their current yield (which they can get from an IO), or trying to reduce their exposure to prepayments of the loans (which they can get from a PO).
Many homeowners saw the values of their homes increase by as much as four times its price in some markets in a five-year span in the early 2000s. Interest-only loans helped homeowners afford more home and earn more appreciation during this time period. However, interest-only loans have contributed greatly to creating the subsequent housing bubble situation, because many borrowers could not afford the fully indexed rate. Interest-only loans may turn out to be bad financial decisions if housing prices drop, causing those borrowers to carry a mortgage larger than the value of the house, which in turn will make it impossible to refinance the house into a fixed-rate mortgage.
Read more about this topic: Interest-only Loan
Famous quotes containing the word perspective:
“All things being equal, I would choose a woman over a man in order to even the balance of power, to insinuate a different perspective into the process, to give young women something to shoot for and someone to look up to. But all things are rarely equal.”
—Anna Quindlen (b. 1952)