Adjustable Rate and Interest-only Mortgages

March 31, 2011

When you start searching for property to buy with an FHA guaranteed loan, you are also shopping for a home loan. Among the many options open to FHA loan applicants is the adjustable rate mortgage or ARM loan. Some borrowers may also be tempted by the interest-only mortgage loan, also described as an I-O mortgage.

There are several areas a borrower should do some homework in before committing to an ARM or I-O mortgage. The first and most obvious is the introductory period where the loan is offered at its lowest interest rates, subject to change over the lifetime of the mortgage.

These introductory periods are used to make the loan as attractive as possible. According to the FDIC, "Many option ARMs have a 1-month or 3-month introductory period at the beginning of the loan. During this period, lenders use a lower interest rate to calculate your payments. For some I-O mortgage payment loans, this introductory period lasts 1, 3, or 5 years."

Once the introductory rate period is over, FHA ARM and FHA insured interest-only mortgages move into an interest rate adjustment period. during this time, minimum monthly payment may not increase right away, but keep in mind that any lack of increase in the monthly FHA mortgage payment doesn't change the fact that the money is owed.

Some borrowers don't realize this and wind up at risk--it's smart to factor in the additional interest rate and increase their monthly payments to ward off negative amortization, where your monthly payments aren't helping whittle down your loan amount.

Eventually, there will be mortgage payment adjustments. According to the FDIC, "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 7.5%. Keep in mind that payment caps do not apply when your loan is recalculated at the normal recalculation period."

The payment cap sounds like a safety valve for the mortgage to keep borrowers out of trouble, but the FDIC warns, "Payment caps also do not apply if your balance grows beyond 110% or 125% of your original mortgage amount." That is one reason why it's so important to avoid negative amortization-when the amount you're paying doesn't keep up with the interest rate changes.

Borrowers considering FHA insured ARM loans or interest only payments must carefully examine the details related to interest rate adjustments, negative amortization risks and other important factors. FHA loan applicants should never make assumptions about any loan--do your research, ask as many questions as you need to make an informed choice on the loan that's best for you.