If you are considering refinancing your mortgage with an interest only mortgage there are several things you need to know to minimize your risk and avoid paying too much. When used correctly interest only mortgages can give you a lower monthly payment; however, with any Adjustable Rate Mortgage there is always the risk of payment shock. Here are several tips to help you decide if interest only refinancing is right for your situation.
What Are Interest Only Mortgage Loans?
Interest only loans are a special type of Adjustable Rate Mortgage where your payment is based only on the interest due for a given month. This interest only payment doesn’t last forever; your mortgage lender is going to want their money back eventually. The duration of your interest only period will be specified in your loan contact and typically lasts for five years. At the end of this interest only period your lender will convert your interest only mortgage to a standard Adjustable Rate Mortgage with a payment based on the time remaining in your loan. When this happens your mortgage payments will go up significantly to include loan principal.
Limiting Your Risk With Interest Only Mortgages
There are safety features built into Adjustable Rate Mortgages to protect you from payment shock. Payment shock occurs when an adjustment to your mortgage rate by the lender raises the payment to an amount you can no longer afford. There two types of caps that protect you from a financial crisis. Periodic caps limit the amount your mortgage rate can go up during an adjustment period or over the lifetime of your loan. Payment caps limit the amount your monthly payment can go up or down following an adjustment to your mortgage rate. Your payment cap can also have a lifetime limit.
Beware Negative Amortization
When you borrow with any type of Adjustable Rate Mortgage you have to make sure that you have both types of caps to protect yourself against negative amortization. Mortgage loans that are negatively amortized are actually growing over time as you make your payments. The goal for any type of mortgage is of course to pay the balance off completely so negative amortization is something you should avoid at all costs. You can prevent negative amortization by ensuring your Adjustable Rate Mortgage includes both payment and periodic (interest rate) caps and by avoiding the ultra-risky option Adjustable Rate Mortgage loan.
You can learn more about your interest only mortgage refinancing options, including expensive pitfalls to avoid with a free video tutorial.