If you are a homeowner with an Adjustable Rate Mortgage (ARM), or are considering taking out an adjustable rate mortgage, there are five things you need to be aware of before diving in. Here are five things to know about your ARM.
Interest Only Mortgages
Most of the adjustable rate mortgages on the market amortize interest and loan principal at the same time. Interest only mortgages do not pay back the loan principal during the interest only period. Your monthly payments will be significantly lower during the interest only period; however, at the end of the interest only period, which can last anywhere from one year to five years, your monthly payment amount will increase significantly. This can come as a shock to many homeowners that pushed that “interest-only thing” to the back of their minds while enjoying the low monthly payment amount. If you have an interest only mortgage you should find out when the interest only period ends as soon as possible; this will help avoid a financial crisis if your monthly budget cannot support the higher payment amount.
Negative Amortization
Negative amortization is a dirty word you could slap your loan officer’s face for neglecting to mention. Adjustable rate mortgages, especially interest only and option loans, have the potential to grow with time rather than diminish with your payments. If you have a standard adjustable rate mortgage rather than one of the more risky varieties, you can still experience negative amortization depending on how the lender structured the interest rate and payment caps. If your monthly payment is not enough to cover the interest due for any given month the lender will add that interest to the principal loan balance; this is “negative amortization.”
Balloon Payments
Mortgages with balloon payments have a large amount of interest or principal due at a specified time. These mortgages are attractive to homeowners because of their low monthly payment amounts; however, if you are unable to make the balloon payment when it becomes due, your only alternative is to refinance or sell your home.
Hybrid Mortgages
Hybrid mortgages are a combination of adjustable rate mortgages and fixed rate mortgages. Most hybrid mortgages behave like fixed rate mortgages for a period, usually five years, and then convert to an adjustable rate mortgage at the end of the fixed rate period. An example of a hybrid mortgage is a 5:1 hybrid loan. This mortgage has a fixed interest rate for five years; at the end of five years the lender will adjust the interest rate to the going rate plus markup every year.
Option Adjustable Rate Mortgages
These mortgages come with four different payment options during the “option” period. The homeowner can choose to make payments based on 30 year amortization, 15 year amortization, interest only, or the minimum option payment. The so called “option” payment does not cover all the interest due for a given month and results in negative amortization. To learn more about your mortgage options as well as how to minimize risk, register for a free mortgage guidebook using the links below.
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Louie Latour specializes in showing homeowners how to avoid common mortgage mistakes and predatory lenders. For a free copy of "Mortgage Refinancing: What You Need to Know," which teaches strategies to find the best mortgage and save thousands of dollars in the process, visit Refiadvisor.com.
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