What should I keep in mind when it comes to an I-O mortgage payment or a payment- option ARM?

Both types of loans can be flexible and allow you to make lower monthly payments during the first few years of the loan. You can repay some of the principal at any time to help keep future payments lower.

Neither loan may be the right choice if the attraction of an initial smaller monthly payment leads you to take out a larger mortgage than you will be able to afford when the interest-only period ends or when the option payments are recalculated.

Eventually you will have to pay back the principal you borrowed, plus any amounts added to the principal as negative amortization.

You will have lower monthly payments only during the first few years. You will have larger payments later–and you will need to have the income to cover those larger payments.

Also, note that

• with an adjustable-rate mortgage, interest-only and option-ARM monthly payments can increase, even during the I-O-payment or option period.

• by making I-O or minimum payments, you will not be building equity in your home by paying down the principal on the loan, even though you are making monthly payments. The equity in your home may increase if the market value of your home increases, but the equity could also go down if the market value of your home goes down.

• with payment-option ARMs, you may be adding to the amount you owe on your mortgage if you pay less than the full interest owed each month.

Comparison of Five $180,000 Mortgage Loans ($200,000 home with a $20,000 down payment)
	Traditional fixed-rate mortgage; 30-year term, 6.7% interest rate	Traditional 5/1 ARM; 30-year term; 6.4% interest rate for first 5 years	Fixed-rate 5-year interest-only mortgage; 30-year term; 6.9% interest rate	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	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%; 7.5% annual payment caps
Initial monthly payment	$1,161	$1,126	$1,035	$960	$630
Monthly payment in year 6 with no rate change	$1,161	$1,126	$1,261	$1,204	$1,308
Monthly payment in year 6 with 2% rate change	$1,161	$1,344	$1,261	$1,437	$1,562
Balance owed after 5 years	$168,882	$168,298	$180,000	$180,000	$195,562
Home equity in year 5 with $20,000 down payment¹	$31,118	$31,702	$20,000	$20,000	$4,438

1. Assumes home prices and housing values stay constant.

If you have any questions, please get in touch with me; I’m always happy to speak with you.