By Sam Spatter
FOR THE TRIBUNE-REVIEW

When Tony Cecchini decided to buy a house in South Fayette Township, Allegheny County, he selected an adjustable-rate mortgage with an interest-only payment for the first five years.

"I did it because it freed up immediately cash I needed to make some repairs to the house and the landscaping, as well as put me in control of when I could repay some of the principal," he said.

Cecchini, 43, a computer consultant with his own company, I.T. Consultants, had been renting since his divorce five years ago.

His mortgage decision reflects a growing trend nationally among home buyers in selecting interest-only loans, especially in California.

An interest-only loan requires the consumer to pay interest accumulated from the loan each month with no deduction on the principal.

What it does for buyers is allow them to qualify for a mortgage that they may not have been able to get if they had selected a traditional mortgage that requires payment monthly of interest and principal.

And it allows them, also, to buy more house for their money.

The loan does have some disadvantages.

Monthly payments will rise dramatically after the interest-only period ends, and, depending on the interest rate, the homeowner may have to consider refinancing or selling the home if he or she is unable to meet the higher payments.

Most lenders feel interest-only loans usually work if the homeowner's income increases as well as the house appreciates in value.

If home sales dip, homeowners could become trapped in a down market and end up with a hefty payment. Lenders often recommend that homeowners make plans to refinance during the early portion of the loan, or use income obtained from other investments to help pay off the principal.

But not all interest-only loans are used to buy houses.

Some individuals get a home equity loan and use the funds to buy a car, go on vacation, or pay off high-interest credit card accounts or private loans.

That's what Tanya Frye did.

The money she obtained through an interest-only home equity mortgage was used for a new car.

She is well acquainted with this type of loan because she initiates interest-only mortgages as a vice president, branch manager for National City Bank in Pittsburgh.

"I took out a home equity mortgage through a line of credit that requires I repay monthly only the interest on the amount of money I used. It also allows me to repay the interest on the loan as fast or as slow as I want," she said.

National City offers interest-only adjustable rate mortgages of three, five or seven years with the length of the interest-only portion determined by the borrower.

Most are amortized over a 30-year period, but 15-year ARMs are available.

Frye said interest-only residential mortgages are not a major product at National City, but it is popular for home equity loans.

Spokesmen for secondary lenders, such as Freddie Mac and Fannie Mae, say the interest-only payment plan is relatively new. While they purchase these loans, they claim there is not enough experience with them to guage their popularity or to determine the percentage of these loans that go into foreclosure.

Allen Fishbein, director of housing and credit policy for the Consumer Federation of America, said he has noticed an increase in the use of interest-only mortgages throughout the nation.

"Based on a survey we conducted regarding adjustable rate mortgages, we asked respondents whether they used interest-only mortgages and found those who did were lower-income buyers, those who were less educated, younger adults and Hispanics," he said.

He knows of no study or survey on how many buyers with interest-only mortgage lost their homes through foreclosure.

Many lenders in the region offer some type of interest-only mortgage.

"Right now, only a few percent of our total mortgages are interest-only loans, but we are seeing an increase in these loans," said Mike Henry, an assistant vice president for underwriting at Dollar Bank.

The program is especially attractive to people who work on commission or receive bonuses, since they can make a lump-sum payment on the principal whenever they have extra funds, he said.

"We offer both the 3/1 and 5/1 ARMs -- fixed rates for the first three or five years -- with rate adjusted annually based on a formula," Henry said. But he expects his company will also offer two new Freddie Mac products -- 10/20 and 15/15 mortgages.

Under the 10/20 program, the homeowner pays interest only the first 10 years, then a full payment -- which includes reducing the principal -- the final 20 years.

The 15/15 works the same way -- 15 years interest only, 15 years full payment.

Henry said in the past, Dollar Bank required a minium downpayment of 20 percent on its interest-only loans. Now, it requires a minium 10 percent down. However, a quarter of 1 percent is added to the interest rate.

"The philosophy behind the interest-only mortgage is that not only does the homeowner make a minimal monthly payment, but since the value of the property is expected to appreciate, the owner will gain from the increased value of the property," said Michael Flynn of Keystone Mortgage in the North Hills.

In addition, the buyer can obtain up to 11 percent more of a house because of the lower payment, he said.

One example is on a $100,000 loan. If both principal and interest are included, the monthly payment is $600, with $500 of it in interest. If the entire $600 went toward interest, home buyers could borrow an additional $20,000, which could mean more house for their money.

At Keystone, the mortgage is available in the five-year, seven-year and 10-year adjustables, all of which are based on a 30-year period.

Most adjustable-rate mortgages have caps on the total increase permitted in the rate.

One of the early companies to offer these types of loans was Washington Mutual, which has 3/1 and 5/1 adjustables.

"It's ideal for home buyers who may only be in the region for a few years, or plan to relocate to another area in the region," said Gary Straub, a vice president.

What makes the program work well in this region is that, although the appreciation rate is not in the double digits annually, housing prices generally appreciate each year so that homeowners may realize an 18 percent to 25 percent increase in the value of their homes over a period of time, he said.

Usually, there is a 5 percent to 7 percent appreciation annually in local housing prices.

While the program seems to work best for buyers who are paying from $500,000 to $1 million for their homes, Straub said he has noticed that young couples, buying their first home, also have started to use the program.

"We offer the one, three, and five-year ARMs as well as the 15/15 fixed-rate mortgage," said Fred Eisenreith, vice president consumer lending at PNCBank.

In addition, PNC has an home equity loan that allows up to seven years of interest-only payments, provided it is a line-of-credit loan.

Eisenreith cautions individuals seeking interest-only loans to be aware of the risk factor involved.

Most houses will appreciate in value to compensate for lack of equity in the home, but that simply may not occur or the increase in value may not be as great as anticipated. He suggests consumers obtain counseling and be comfortable with the product before deciding on the loan.

John Held, director of mortgage banking at Citizens Bank, said his company offers a one-month, one-year, three-year, five-year and 10-year adjustable rate mortage with interest payments only for the stated period on a 30-year mortgage, with the five-year the most popular, he said.

Interest-only loans are not new to the mortgage industry.

Fannie Mae, which buys loans on the secondary market, has been buying the 15-year and 30-year fixed-rate loans under its interest-only program, called InterestFirst, since April 2001.

According to Alfred King, a Fannie Mae spokesman, the homeowner can obtain a 30-year loan with 15-year interest only and the remaining 15 years full payment.

Also available are three-year, five-year, seven-year and 10-year adjustables with interest-only payments the initial number of years, on a 30-year loan.

"These loans have been pretty popular, especially among financial-savvy borrowers," he said.

They are particularly popular among home buyers in California and other West Coast communities, said Sandy Cutts, a Fannie Mae spokeswoman.

"We find 30 percent of the loans we buy in California are interest-only, and that's generally due to the high price of housing there," she said. "Some buyers could not afford to purchase a home without an interest-only loan."

California-based Countrywide Home Loans, which has a presence in the Pittsburgh region, has been active for several years in the interest-only mortgage market, said Vijay Lala, executive vice president for product support and development.

"Typically, these borrowers select an adjustable-rate mortgage line of credit, with interest-only payments based on one-month to a 30-year-fixed-rate loan," he said.

Lala said Wall Street investors, such as Morgan-Stanley or Goldman Sachs, have purchased interest-only jumbo loans, those that exceed Fannie Mae's maximum.

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