"Debt-Leveragers"
Interest-only payment options began to be offered to the masses not as a way to leverage their money, but rather as a way to borrow more money while not increasing the monthly payment. In one example, the monthly payment of $600; about $500 of that is interest, and only about $100 goes toward repaying the principal. With an interest-only arrangement, all of the $600 pays the interest cost. That extra $100 in monthly flexibility would allow you to borrow an additional $20,000 -- enough to be the high bidder, or to help buy a somewhat larger home. Borrowers employing this method aren't "cash-flow" or "income-leveraging" borrowers. What they're doing is buying themselves more debt. Call them "debt leveragers."
Leveraging and Risk
Of course, sophisticated investors understand that with increased leverage comes increased risk. In this case, borrowers who "debt leverage" themselves into a more expensive home, with a larger mortgage, gamble not only that their income will rise in the years ahead, but that the home will appreciate, as well. Since they're not reducing the principal balance, they're not building any equity in their home. Instead, they're counting on the market to do that for them. That's not so much of a gamble when homes are appreciating, but it could spell big trouble in a down real estate market. At the same time, they're betting that when -- not if -- those higher payments come due, they will have increased their income enough to cover those increases. And those increases can be substantial.
