We discuss a lot of aspects of the FHA home loan process, but sometimes it’s a very good idea to go right to the source–the FHA itself–to get the agency’s take on certain aspects of the FHA loan process. The FHA official site–www.FHA.gov–has some good advice for borrowers contemplating their loan options including interest-only loans and adjustable rate mortgages (ARMs).
What does the agency say to potential borrowers about these kinds of loans? One of the first pieces of advice is along the basic lines of, “do your homework, and be sure to read the fine print”. The FHA official site actually directs readers to look at another official government website–the FDIC official site–for some sound advice on how to approach the mortgage loan process where ARMs and interest-only mortgages are concerned:
“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 (1) pay only the interest on the loan during the first few years of the loan term or (2) make only a specified minimum payment that could be less than the monthly interest on the loan.”
It doesn’t matter whether a borrower is contemplating a new purchase loan or a refinance loan with either of these two options–the same basic advice applies to both transactions. The FDIC urges potential borrowers to carefully view the risks and benefits of these loans compared to fixed rate mortgages to decide which the applicant is more comfortable with.
For example, when it comes to Interest Only mortgages or refinancing, the FDIC site explains, ” 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.”
Borrowers will find that interest only payment plans feature adjustable interest rates, “which means that the interest rate and monthly payment will change over the term of the loan. The changes may be as often as once a month or as seldom as every 3 to 5 years, depending on the terms of your loan. For example, a 5/1 ARM has a fixed interest rate for the first 5 years; after that, the rate can change once a year (the “1” in 5/1) during the rest of the loan.”
Furthermore, “The I-O payment period is typically between 3 and 10 years. 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. For example, if you take out a 30-year mortgage loan with a 5-year I-O payment period, you can pay only interest for 5 years and then both principal and interest over the next 25 years. Because you begin to pay back the principal, your payments increase after year 5.”
Some borrowers apply for an ARM loan with the intention of refinancing later into a fixed-rate mortgage. This type of long term borrowing strategy is good to consider regardless of whether you plan to use a fixed-rate or ARM loan or any other type of loan product; the idea that the borrower has a long term plan for dealing with the loan is the important thing. Looking ahead and planning for the future is an important aspect of being a fully informed borrower.
You can learn more about interest only loans and ARM loans in general at the FDIC official site.
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