Interest Only Mortgage Loans / Payment Option ARMS (continued)
When might an I-O interest only mortgage payment or a payment-option ARM be right for you?
Despite the risks of these loans, an I-O interest only mortgage payment or a payment-option ARM might be right for you if the following apply:
- You have modest current income but are reasonably certain that your income will go up in the future (for example, if you're finishing your degree or training program),
- You have sizable equity in your home and will use the money that would go toward principal payments for other investments, or
- You have irregular income (such as commissions or seasonal earnings) and want the flexibility of making I-O or option-ARM minimum payments during low-income periods and larger payments during higher-income periods.
When might an I-O mortgage payment or a payment-option ARM not make sense?
Interest-only or option-ARM minimum payments may be risky if you won't be able to afford the higher monthly payments in the future. For example, suppose you are in the market for a home and can afford a monthly payment of about $1,100. Depending on the interest rate, with a traditional 30-year, fixed-rate mortgage, you might expect to get a $180,000 mortgage. A lender or broker could offer you an I-O mortgage payment of $1,100 monthly that might enable you to get a $215,000 mortgage--and, therefore, a more expensive house. But keep in mind that your payments could go up because of interest rate increases when the I-O period ends, or when the loan is recalculated. Your $1,100 monthly payment could jump to $1,340 or more. If you cannot reasonably expect to make this larger payment when the time comes, you might want to think about a different type of loan.
What are the alternatives to interest only mortgage payments and payment-option ARMs?
If you are not sure that an interest only mortgage payment or a payment-option ARM makes sense for you, there are several other alternatives you could consider. ind out if you qualify for a community housing program that offers lower interest rates or reduced fees for first-time homebuyers, making homeownership more affordable.
Consider a fixed-rate mortgage or a fully amortizing ARM. Shop around for terms and features that fit your needs and your budget.
Take more time to save for a larger down payment, reducing the amount you need to borrow and making your mortgage payments more affordable.
Look for a less expensive home. Once you build up equity, you could buy a more expensive home.
What are some important target dates in an interest only mortgage or a payment-option ARM?
Introductory period. Many option ARMs have a 1-month or 3-month introductory period at the beginning of the loan. During this period, lenders use a lower interest rate to calculate your payments. For some interest only mortgage payment loans, this introductory period lasts 1, 3, or 5 years.
Interest rate adjustment period. Most payment-option ARMs have interest rates that adjust monthly after the introductory period. You could find that the interest you owe increases even though your minimum payment stays the same each month, adding to your negative amortization. Typical interest rate adjustment periods for an I-O mortgage are monthly, every 6 months, or once a year.
Payment adjustments. Most I-O payment mortgages and payment-option ARMs have payments that adjust once a year. In addition, most of the adjustments on payment-option ARMs are limited by a payment cap, usually 7.5%. Keep in mind that payment caps do not apply when your loan is recalculated at the normal recalculation period. Payment caps also do not apply if your balance grows beyond 110% or 125% of your original mortgage amount.
Recalculation period. With a payment-option ARM, your loan will be recalculated, or recast. The recalculation period is usually 5 years, but it can vary depending on the terms of your loan. When your loan is recalculated, the 7.5% payment cap does not apply, so you could see a large change in your monthly payment. After your loan is recalculated, you will still have the option to make a minimum payment. I-O loans are recalculated at the end of the option period (usually 3, 5, or 10 years); after that you will pay back both the principal and interest for the remaining term of the loan.
