Interest-Only Mortgages in Marin County: Benefits, Risks & Building Wealth Through Real Estate

Mortgage Magic

The article at the bottom {bracketed} is from Compass’s Chief Evangelist. He offers an interesting and somewhat unconventional way of looking at the benefits of a mortgage. His example uses an interest-only loan, which prompted me to reflect on how this type of financing has played a role in Deirdre’s and my own experience in real estate—and, more importantly, in our financial growth through real estate.

I understand that many people are committed to the security and predictability of a 30-year fixed-rate mortgage. For many homeowners, that is absolutely the right choice. But I also think it is worth recognizing that there are other financing options that carry additional risk but, when used thoughtfully and within one’s financial means, can provide significant opportunity.

One of those options is the interest-only loan.

Deirdre and I have utilized interest-only financing multiple times throughout our real estate investments here, in Marin County. Our primary reason has been simple: it has allowed us to purchase properties that otherwise would have been outside our comfort zone based on the monthly payment.

We have also found, through our own experience, that more desirable properties often have greater potential for long-term appreciation and sometimes short-term appreciation too. One example was a home we purchased, in San Rafael's Marinwood neighborhood, for $900,000. A conventional 30-year fixed mortgage would have put the payment beyond what we were comfortable with, so we took advantage of an interest-only loan. We completed approximately $170,000 in improvements and updates, over a 5 year period, maintained a manageable payment while doing the work, and ultimately sold the property five years later for a significant profit.

That represented a substantial gain over five years. Certainly, the Marin market was favorable during that period, market conditions played an important role, and we often had to live in a bit of a construction zone. But without the interest-only financing, we would not have been able to purchase the property comfortably in the first place. The lower payment, via the interest only option, in addition gave us more capital for improvements and those improvements resulted in a great gain. 

The proceeds from that sale allowed us to purchase another property, in Novato, again using an interest-only loan. We purchased that home for $2.5 million, and based on its projected value, we anticipate selling it in the near future in the $3.250 million to $3.750 million range, after approximately five years. 

Again, a conventional 30-year fixed loan would have pushed the payment beyond our comfort level. The interest-only structure allowed us to control a more valuable asset while maintaining a payment we could comfortably manage.

We have also used interest-only financing with investment properties.

For example, we purchased one property for $460,000 and financed $368,000 with an interest-only loan. Including taxes our monthly payment is approximately $1,727, while the property generates about $3,400 per month in rent. In addition to the positive cash flow, the property has appreciated approximately $280,000 since we purchased it.

We have another investment property in San Rafael that has also performed well utilizing an interest only loan. We purchased it in 2017 for $750,000, and it is now worth approximately $960,000. It nets roughly $1,000 per month in income, after the loan and taxes are paid, all the while having gained approximately $210,000 in equity.

I’m not suggesting that an interest-only or adjustable-rate mortgage is right for everyone. It carries additional risk, particularly if rates rise, the loan eventually requires principal payments, or the property does not appreciate as expected. It requires financial discipline, adequate reserves, and a clear understanding of the loan terms.

My point is simply that I would not villainize the adjustable-rate, interest-only mortgage. Instead I would encourage you to look at it as a potential vehicle for gaining wealth. 

For us, it has been a useful financial tool. It allowed us to buy properties that we otherwise would not have been able to afford, improve them, build equity, generate income, and ultimately move that equity into larger investments.

A mortgage is debt, but the way that debt is structured can have a significant impact on what opportunities are available to you. In our experience, the interest-only mortgage wasn’t simply a way to lower a monthly payment—it was a tool that helped us build wealth through real estate.

{----- Mortgage Magic

Most people mention the tax deduction for interest paid on a mortgage. Many mention the $250,000 capital gains tax exemption for singles and $500,000 for couples when selling a home....but there is one hidden advantage besides many others to buying a home, and it lies in the mortgage....

When you take out a mortgage for say, $500,000.....over time, inflation erodes the value of that money, even when inflation is around 2% annually. Imagine taking out an interest-only mortgage for $500k, paying interest for 15 years....and then when the 15-year period ends, you still owe that $500,000.... well, 2% inflation per year, annualized, erodes the value of that $500k. By the time that 180th month rolls around, the buying power of $500,000 at the time of taking out the mortgage will be closer to....$351,507 at the time of paying it off.....meaning when you pay off your $500k loan, it will only 'cost' you the equivalent of $351k..... that's an additional 'benefit' of around $10k per year. Not nothing! (Now imagine what 3 or 4% inflation does to debt!)

If you invest $30k per year (your tax savings plus your inflation savings) at 8% return, adding $30k per year over 15 years, compounded.....that will amount to.....$964k.... —-- } (Leonard Steinberg)