Interest Only Mortgage Loans / Payment Option ARMS (continued)
What should I keep in mind when it comes to an I-O mortgage payment or a payment-option ARM?
Both types of loans can be flexible and allow you to make lower monthly payments during the first few years of the loan. You can repay some of the principal at any time to help keep future payments lower.
Neither loan may be the right choice if the attraction of an initial smaller monthly payment leads you to take out a larger mortgage than you will be able to afford when the interest-only period ends or when the option payments are recalculated.
Eventually you will have to pay back the principal you borrowed, plus any amounts added to the principal as negative amortization.
You will have lower monthly payments only during the first few years. You will have larger payments later--and you will need to have the income to cover those larger payments.
Also, note that with an adjustable-rate mortgage, interest-only and option-ARM monthly payments can increase, even during the I-O-payment or option period. And, by making I-O or minimum payments, you will not be building equity in your home by paying down the principal on the loan, even though you are making monthly payments. The equity in your home may increase if the market value of your home increases, but the equity could also go down if the market value of your home goes down. With payment-option ARMs, you may be adding to the amount you owe on your mortgage if you pay less than the full interest owed each month.
Comparison of Five $180,000 Mortgage Loans
($200,000 home with a $20,000 down payment)
(1) Traditional fixed-rate mortgage; 30-year term, 6.7% interest rate
Initial monthly payment $1,161
Monthly payment in year 6 with no rate change $1,161
Monthly payment in year 6 with 2% rate change $1,161
Balance owed after 5 years $168,882
Home equity in year 5 with $20,000 down payment (see note 1) $31,118
(2) Traditional 5/1 ARM; 30-year term; 6.4% interest rate for first 5 years
Initial monthly payment $1,126
Monthly payment in year 6 with no rate change $1,126
Monthly payment in year 6 with 2% rate change $1,344
Balance owed after 5 years $168,298
Home equity in year 5 with $20,000 down payment (see note 1) $31,702
(3) Fixed-rate 5-year interest-only mortgage; 30-year term; 6.9% interest rate
Initial monthly payment $1,035
Monthly payment in year 6 with no rate change $1,261
Monthly payment in year 6 with 2% rate change $1,261
Balance owed after 5 years $180,000 $180,000
Home equity in year 5 with $20,000 down payment (see note 1) $20,000
(4) 5/1 interest-only ARM; 30-year term; 5 years of I-O payments then 25 years of principal and interest payments; 6.4% interest rate for first 5 years
Initial monthly payment $960
Monthly payment in year 6 with no rate change $1,204
Monthly payment in year 6 with 2% rate change $1,437
Balance owed after 5 years $180,000
Home equity in year 5 with $20,000 down payment (see note 1) $20,000
(5) Payment-option ARM; 30-year term; 5 years of minimum payments then recast for remaining term; starting interest rate of 1.6% for 1 month, then 6.4%; 7.5% annual payment caps
Initial monthly payment $630
Monthly payment in year 6 with no rate change $1,308
Monthly payment in year 6 with 2% rate change $1,562
Balance owed after 5 years $195,562
Home equity in year 5 with $20,000 down payment (see note 1) $4,438
Note 1: Assumes home prices and housing values stay constant
Next Topic: Can't Afford a House? Maybe you can with an IDA
Mortgages
Interest Only Mortgages and Payment Option ARMS
