To make homeownership more affordable and attainable, lenders made variations to the traditional 30-year, fixed-rate mortgage loan by introducing the adjustable rate mortgage (ARM). While the most common ARMs include a predetermined interval during which borrowers cover both interest and principal, lenders also offer interest-only ARMs by which borrowers pay only the interest on the loan for a specified period. The benefit is that payments are kept low for a set number of years, enabling borrowers to financially prepare themselves for as soon as the payment amount resets higher to account for principal amortization.
3/1 Interest-Only ARM
A 3/1 interest-only ARM is a form of loan where the debtor pays a fixed-interest rate for the initial three years. Then, the loan converts into an adjustable-rate mortgage where the interest rate varies yearly based on an index like the London Interbank Offered Rate (LIBOR). To ascertain the interest rate, add the lender-specified margin to the current index rate. For example, assume the lender-specified margin is 3 percent and the present rate on the one-year LIBOR is also 3 percent. The interest rate on the loan is therefore 6 percent. Be aware that during the initial three years of the loan, not one of the obligations goes to amortizing the principal. Hence, the borrower is going to be left with higher mortgage obligations (even if premiums remain the same) following the loan resets to account for principal amortization. For example, a borrower with a $200,000 mortgage plus a 6% introductory rate is going to have a monthly payment of $1,000 for the initial three years. Then, if the premiums remain the same, the mortgage payments will grow to $1,262 on a 30-year loan.
10/1 Interest-Only ARM
A 10/1 interest-only ARM is a kind of loan where the debtor pays a fixed-interest rate for the initial ten years. Then, the loan converts into an adjustable rate mortgage where the interest rate varies yearly based on an index such as LIBOR. None of the obligations made during the initial ten years goes to repay the key. Therefore, the debtor will face higher monthly payments once the mortgage registers to account for loan payable. For example, a borrower with a $200,000 loan plus a 6% introductory rate is going to have an interest-only monthly payment of $1,000 for the initial ten years. Then, the mortgage payments will reset higher. If interest rates remained the same, the debtor will have monthly payments of $1,453 on a 30-year loan.
5/1 Jumbo Interest-Only ARM
A loan is a mortgage that exceeds a specific quantity. In 2007, this amount has been put to $417,000 for the continental United States. A 5/1 jumbo interest-only ARM functions like others of its own variety. It starts by offering a fixed-interest rate for the initial five years of the loan term before resetting into an adjustable-rate mortgage having a yearly fluctuating interest rate. Suppose a borrower takes out a 30-year 5/1 interest-only ARM with an introductory rate of 6 per cent for the amount of $600,000. For the initial five years, the debtor will have monthly payments of $3,000. Then (supposing interest rates remain the same), the borrower will have monthly payments of $3,911 to account for loan amortization.