Top option minimum trade
The secure Internet channel for FDIC-insured institutions to conduct business and exchange information with the FDIC Owning a home is part of the American dream. But high home prices may make the dream seem out of reach. To make monthly mortgage payments more affordable, many lenders offer home loans that allow you to pay only the interest on the loan during the first few years of the loan term or make only a specified minimum payment that could be less than the monthly interest on the loan Whether you are buying a house or refinancing your mortgage, this information can help you decide if an interest-only mortgage payment an I-O mortgage --or an adjustable-rate mortgage ARM with the option to make a minimum payment a payment-option ARM --is right for you Lenders have a variety of names for these loans, but keep in mind that with I-O mortgages and payment-option ARMs, you could face "payment shock. The unpaid interest is added to your mortgage balance so that you owe more on your mortgage than you originally borrowed Be sure you understand the loan terms and the risks you face. Skip to content Option do you need to ask when shopping for an I-O mortgage payment or a payment-option ARM? What are the risks with I-O mortgage payments and payment-option ARMs? When might an I-O mortgage payment or a payment-option ARM be right for you? When might an I-O mortgage payment or a payment-option ARM not make sense? What are the alternatives to I-O mortgage payments and payment-option ARMs? What are some important target dates in an I-O mortgage or a payment-option ARM? Does the type of loan and loan payment plan make much difference? What should I keep in mind when it comes to an I-O mortgage payment or a payment-option ARM? Traditional mortgages require that each month you pay back some of the money you borrowed the principal plus the interest on that money. The principal you owe on your mortgage decreases over the term of the loan. In contrast, an I-O payment plan allows you to pay only the interest for a specified number of years. After that, you must repay both the principal and the interest. Most mortgages that offer an I-O payment plan have adjustable interest rates, which means that the interest rate and monthly payment will change over the term of the loan. After that, your monthly payment will increase--even if interest rates stay the same--because you must pay back the principal as well as the interest. The options typically include a traditional payment of principal and interest which reduces the amount you owe on your mortgage. These payments may be based on a set loan term, such as a 15- 30- or 40-year payment schedule an interest-only payment which does not change the amount you owe on your mortgage a minimum or limited payment which may be less than the amount of interest due that month and may not minimum down any principal. If you choose this option, the amount of any interest you do not trade will be added to the principal of the loan, increasing the amount you owe and increasing the interest you will pay Interest rates. After that, the rate usually rises to a rate closer to that of other mortgage loans Your monthly payments during the first year are based on the initial low rate, meaning that if you only make the minimum payment, it may not cover the interest due. The unpaid interest is added to the amount you owe on the mortgage, resulting in a highter balance This is known as negative amortization. Also, as interest rates go up, your payments are likely to go up Payment changes. Many payment-option ARMs limit, or cap, the amount the monthly minimum payment may increase from year to year. For example, if your loan has a payment cap of 7. At this point, your payment will be recalculated lenders use the term recast based on the remaining term of the loan. The payment cap does not option to this adjustment. If your loan balance has increased, or if interest rates have risen faster than your payments, your payments could go up a lot Ending the option payments. Your loan would be recalculated and you would pay back principal and interest based on the remaining term of your loan. It is likely that your payments would go up significantly Use the Mortgage Shopping Worksheet to compare different loan products. Ask lenders or brokers about the details of their loans and about the different loan options they offer. It is risky to focus only on your ability to make I-O or minimum payments, because you will eventually have to pay all of the interest minimum some of the principal each month. When that happens, the payment could increase a lot, leading to payment shock. If you have a payment-option ARM and make only minimum payments that do not include all of the interest due, the unpaid interest is added to the principal on your mortgage, and you will owe more than you originally borrowed. And if your loan balance grows to the contract limit, your monthly payments would go up. You may be able to avoid payment shock and higher monthly payments by refinancing your mortgage. Some mortgages, including I-O mortgages and payment-option ARMs, have prepayment penalties. So if you refinance your loan during the prepayment penalty period, you could owe additional fees or a penalty. This is not considered "prepayment," and there usually is no penalty for these extra amounts Falling housing prices. If housing prices fall, your home may not be worth as much as you owe on the mortgage. Even if home prices stay the same, if you have negative amortization, you may owe more on your mortgage than you could get from selling your home. Also, you may trade it difficult to refinance. And if you decide to sell, you may owe the lender more than the amount you receive from the buyer. 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. 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 If you are not sure that an I-O mortgage payment or a payment-option ARM makes sense for you, there are several other alternatives you could consider Find 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 Introductory period. Many option ARMs have a 1-month or 3-month introductory period at the beginning of the loan. 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. 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. Keep in mind that payment caps do not apply when your loan is recalculated at the normal recalculation period. When your loan is recalculated, the 7. After your loan is recalculated, you will still have the option to make a minimum payment. During the first few years of a traditional mortgage loan, most of your monthly payment trade to interest. The rest goes toward the principal, so that you start to build equity in your home through payments. Thus, the amount you owe declines and you own more of your home. If you make interest-only payments, you are not building equity. At the beginning of a mortgage, I-O and option-ARM payments are likely to be lower than traditional mortgage payments. But when the I-O payment period ends or when your payment-option ARM loan is recast, your payments could change a lot. With a 30-year payment-option ARM, at the end of the first 5-year period, your loan is recalculated based on a 25-year term. Before taking an I-O mortgage or a payment-option ARM, think about not only how you will make the initial payments but also whether you can make the payments in the years ahead 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 option. You will have larger payments later--and you will need to have the income to cover those larger payments with an adjustable-rate mortgage, interest-only and option-ARM monthly top can increase, even during the I-O-payment or option period 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 Assumes home prices and housing values stay constant. Return to table Assumes home prices and housing values stay constant. Return to table periodic caps, which limit the interest-rate increase from one adjustment period to the next, and overall caps, which limit the interest-rate increase over the life of the loan. Rising monthly payments and payment shock. And if you decide to sell, you may owe the lender more than the amount you receive from the minimum Back to top When might an I-O mortgage payment or a payment-option ARM be right for you? 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 Back to top What are the alternatives to I-O mortgage payments and payment-option ARMs? If you are not sure that an I-O mortgage payment or a payment-option ARM makes sense for you, there are several other alternatives you could consider Find 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 top amortizing ARM. Once you build up equity, you could buy a more expensive home Back to top What are some important target dates in an I-O mortgage or a payment-option ARM? Yes for both the growth of your investment in your home and the amount of your monthly payments during the term of the loan Equity growth. Skip to content What is an I-O mortgage payment? What is a payment-option ARM? What do you need to ask when shopping for an I-O mortgage payment or a payment-option ARM? Option Shopping Worksheet What are the risks with I-O mortgage payments and payment-option ARMs? After that, you must repay both the principal and the interest Most mortgages that offer an I-O payment plan have adjustable interest rates, which means that the interest rate and monthly payment will change over the term of the loan. A payment-option ARM is an adjustable-rate mortgage that allows you to choose among several payment options each month. It is likely that your payments would go up significantly Back to top What do you need to ask when shopping for an I-O mortgage payment or a payment-option ARM? Use the Mortgage Shopping Worksheet to compare different loan products. What is the most my minimum monthly payment could be after months? Return to table Glossary Adjustable-rate mortgage Top A mortgage that does not have a fixed interest rate. The rate changes during the life of the loan in line with movements in an index rate, such as the rate for Treasury securities or trade Cost of Funds Index Amortizing loan Monthly payments are large enough to pay the interest and reduce the principal on your mortgage Cap, interest rate A limit on the amount your interest rate can increase. Interest caps come in two versions periodic caps, which limit the interest-rate increase from one adjustment period to the next, and overall caps, which limit the interest-rate increase over the life of the loan. By law, virtually all ARMs must have an overall cap Cap, payment A limit on how much the monthly payment may change, either each time the payment changes or during the life of the mortgage. Payment caps do not limit the amount of interest the lender is earning, so they may lead to negative amortization Equity The difference between the fair market value of the home and the outstanding mortgage balance Good faith estimate The Real Estate Settlement Procedures Act RESPA requires your mortgage lender to give you a good faith estimate of all your closing costs within 3 business days of submitting your application for a loan, whether you are purchasing or refinancing a home. The actual expenses at closing may be somewhat different from the good faith estimate Index The index is the measure of interest-rate changes that the lender uses to decide how much the interest rate on an ARM will change over time. No one can be sure when an index rate will go up or down. Some index rates tend to be higher than others, and some change more often. You should ask your lender how the index for any ARM you are considering has changed in recent years, and where the index is reported Interest The price paid for borrowing money, usually given in percentages and as an annual rate Margin The number of percentage points the lender adds to the index rate to calculate the ARM interest rate at each adjustment Negative amortization Occurs when the monthly payments do not cover all the interest owed. The interest that is not paid in the monthly payment is added to the loan balance. This means that even after making many payments, you could owe more than you did at the beginning of the loan Prepayment penalty Minimum fees that may be due if you pay off the loan early by refinancing your home. These fees may make it too expensive to get top of the loan. If your loan includes a prepayment penalty, be aware of the penalty you would have to pay.
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