One of the fairy tales borrowers frequently hear is that a loan carrying an interest-only (IO) option is priced better than the same loan without the option. It is a fairy tale because the IO allows the borrower to avoid paying down the loan balance, which makes it riskier to the investor, and greater risk should mean a higher price. At the wholesale level, where prices are extremely competitive because they are directed to mortgage brokers, the IO version of a loan always carries a higher price than the same loan without the IO option. This is also true at retail Internet shopping sites, such as those of the Upfront Mortgage Lenders (UMLs) listed on my site. Sometimes the price difference is small, sometimes it is large -- but I have never seen IOs priced lower. Yet in the bazaar...
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