If you are in the process of refinancing and are considering interest only mortgages, there are several things you should know to reduce your risk. Interest only mortgages are suitable for homeowners that need a low monthly payment for a short period of time; however, these loans are often abused by people who don’t understand how they work. Here are a several tips to help you decide if refinancing with interest only mortgages is right for you.
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Adjustable Rate Mortgages 101
Interest only mortgages are a type of Adjustable Rate Mortgage. These loans are called “adjustable” because the lender periodically changes the interest rate to the loan’s index plus their margin. Adjustable Rate Mortgages are based on a number of different indexes ranging from the Federal T-bills to the London Interbank Offered Rate Index. The index that your interest only mortgage is tied to will be specified in your loan contract. Margin is your lender’s markup of the index for a profit; the amount of margin on your loan is determined by your credit and the lender you have chosen. When shopping for any Adjustable Rate Mortgage it is important to compare the margin from one lender to the next because this markup has an impact on your monthly payment amount.
Interest Only Adjustable Rate Mortgages
Interest only mortgages are a special type of Adjustable Rate Mortgage where your payment amount in the beginning is based only on the amount of interest due that month. Because you’re only paying the interest due, during the interest-only period you will not pay down any of your loan balance. What many homeowners don’t realize is that the interest only period does not last forever. Eventually the lender is going to want their money back and when this happens your mortgage payments will go up.
The length of your interest-only period is specified in your loan contract and typically lasts for up to five years. When the lender resets your loan you will have a mortgage payment amortized for the time remaining in your loan contract. Suppose for example that you take out a 30 year, interest only adjustable rate mortgage with a 5 year interest only period. At the end of the interest only period your payments will be based on a repayment period of 25 years. This means your payments will be much higher than a standard 30 year, adjustable rate mortgage.
As long as your budget can support the new, higher payment amount you shouldn’t have a problem when the lender resets your mortgage. Payment shock occurs for homeowners who are not expecting the higher payment because they don’t understand how interest only mortgages work and their budgets cannot support the payments. If you find yourself in this situation you could be facing foreclosure in as little as 120 days if your mortgage payment becomes too much to manage.
Refinancing as an Option
At the end of your interest only period you do have the option of refinancing before your payments go up. By choosing another interest only mortgage or opting for a less risky hybrid adjustable rate mortgage you can minimize your risks of payment shock while taking advantage of the lower rates offered by interest only mortgages.
You can learn more about your mortgage refinancing options, including strategies for minimizing your risk and avoiding lender junk fees by registering for a free video tutorial. These videos were produced by a retired mortgage broker and will show you how to refinance with a wholesale mortgage rate without paying too much. Click here to register for your free mortgage videos.