At a time when home values in most areas are appreciating at a rapid pace, the key to sustaining property sales and rising home values is the monthly mortgage payment. Hold down monthly costs and strong sales are virtually assured -- just look at the rates seen during the past two years, and then consider where sale volume would be if rates were 8, 9 or 10 percent.

In addition to low rates, there are other ways to increase affordability. More liberal qualification standards and less down also make real estate more attractive.

Another strategy is to reduce monthly payments by reverting to interest-only "term" mortgages similar to those widely used in the 1930s. The interest-only mortgage allows a borrower to make monthly payments equal to the loan's interest cost rather than the combined expense of interest and debt reduction, the type of "amortizing" payment made by most borrowers today.

While monthly cash costs are lower with interest-only financing, the overall cost of the loan is substantially greater than the expense of a self-amortizing mortgage.

For example: A $300,000 loan at 6 percent has an interest-only monthly cost of $1,500. The same loan at the same rate amortized over 30-years requires a monthly payment of $1,799. While $1,5000 may be affordable, $1,800 may be too much for many borrowers, thus for them the real choice is interest-only financing or no purchase.

The catch is that interest-only loans are also expensive. At the end of 10 years the interest-only borrower would have paid out $180,000 in interest and would still owe the original $300,000 -- a total of $480,000. The borrower with the self-amortizing loan would have paid interest worth $166,937 and the remaining loan balance will amount to $251,057 -- a total of $417,994. Benefit to the lender: An extra $62,006.

Now the Office of the Comptroller of the Currency, a part of the Treasury Department, has come out with new regulations that will appropriately chill the federally-chartered banks it oversees.

As part of its predatory lending enforcement process, the OCC says it will take action against federally-chartered banks and their operating subsidiaries if special subsidized mortgages with "terms favorable to consumers" are somehow refinanced with "new loans that do not provide a tangible economic benefit" to borrowers.

The OCC also says it will move against the lenders it regulates if they make "subprime mortgage loans that involve a payment schedule in which regular periodic payments do not cause the principal balance to decrease."

Interest-only loans are surely examples of mortgages where the "regular periodic payments do not cause the principal balance to decrease." But why be concerned just about subprime borrowers? What about other borrowers? Should there be more restrictions on interest-only financing in general? Sophisticated borrowers with substantial assets should surely have the option of interest-only mortgages. However, marginal borrowers -- those on the cusp of affordability -- should be seen as poor candidates for such mortgages. A good test might be this: A borrower who qualifies for an amortizing loan with a solid downpayment should have the option of interest-only financing. Those who cannot afford self-amortizing loans should not have access to interest-only mortgages because their credit and finances suggest excess lender risk.

Not only are tighter standards for interest-only loans a benefit to borrowers, they also benefit lenders -- the OCC's main concern. Interest-only loans represent lender considerable risk because the original loan amount remains outstanding until the interest-only portion of the loan ends -- if it ever ends.

If property values do not rise or if they actually decline then in some circumstances, the value of the house may be insurgent to repay the debt -- and that's trouble for lenders.

Think it can't happen? Even in today's supercharged housing market, it's absolutely possible for property values to drop. A survey by the National Association of Realtors of 129 metro areas showed that 62 areas had double-digit price increases in 2004 -- and also that four areas had price declines.

There's no doubt that consumer groups will look at the new OCC standards and push them to the limit. When borrowers fail and foreclosures loom, you can bet that lenders will face new scrutiny. That's fair because the revised OCC standards now say that lenders have far more responsibility than in the past for interest-only loans, a standard everyone should welcome.

For more articles by Peter G. Miller, please press here.

Published: February 22, 2005

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