Yes. . . for both the growth of your investment in your home and the amount of your monthly payments during the term of the loan.
Equity growth. During the first few years of a traditional mortgage loan, most of your monthly payment goes to interest. The rest goes toward the principal, so that you start to build equity in your home through payments. Thus, the amount you owe declines and you own more of your home. If you make interest-only payments, you are not building equity. And if you make only the minimum payments with a payment-option ARM, you may actually be adding to the amount you owe (and decreasing your equity) because unpaid interest is added to the loan’s principal. For example, if you were to buy a $200,000 home with a 10% downpayment and a $180,000 mortgage, here’s what your home equity might look like after 5 years (with no changes in property value) with different kinds of loans.
Loan Type |
Loan Balance After 5 years |
Equity After 5 years |
Traditional fixed-rate mortgage; 30-year term; 6.7% interest rate | $168,882 | $31,118 ($20,000 down payment plus $11,118 paid on mortgage) |
Traditional 5/1 ARM; 30-year term; 6.4% for first 5 years | $168,298 | $31,702 ($20,000 down payment plus $11,702 paid on mortgage) |
5/1 interest-only ARM; 30-year term; 5 years of I-O payments, then 25 years of principal and interest payments; 6.4% interest rate for first 5 years | $180,000 | $20,000 ($20,000 down payment) |
Payment-option ARM; 30-year term; 5 years of minimum payments, then recast for remaining term; starting interest rate of 1.6% for 1 month, then 6.4%; assume no rate increases | $195,562 | $4,438 ($20,000 down payment minus $15,562 negative equity) |
Payment-option ARM; 30-year term; 5 years of minimum payments allowed, then recast for remaining term; starting interest rate of 1.6%, then 6.4%; 7.5% annual payment cap; assume rate increases 2% per year up to 12.4%. This loan will reach the 125% balance limit in month 49 and will be recast as an amortizing loan at the beginning of year 5. | $223,432 | -$22,432 ($20,000 down payment minus $42,432 in negative equity) |
These numbers are only examples; your balance will depend on the type of loan, the interest rate, and how often the interest rate changes.
Monthly payments. At the beginning of a mortgage, I-O and option-ARM payments are likely to be lower than traditional mortgage payments. But when the I-O payment period ends or when your payment-option ARM loan is recast, your payments could change a lot. If you have a 30-year mortgage with a 5-year I-O payment, you will have only 25 years, instead of 30, to repay the principal, and your monthly payment will rise. With a 30-year payment-option ARM, at the end of the first 5-year period, your loan is recalculated based on a 25-year term. In some cases your monthly payment could double or even triple.
The table below shows an example of the differences over 5 years in the monthly payment of 5 different mortgage loans, all with the original loan amount of $180,000.
If you choose the minimum-payment option ARM to lower your monthly payment to $630 because you cannot afford higher monthly payments, will you be able to afford the monthly payments in the future? Before taking an I-O mortgage or a payment-option ARM, think about not only how you will make the initial payments but also whether you can make the payments in the years ahead.
I hope you’re having a great day – let me know if you need anything.