Mortgage Loan Basics Interest Only Loans Pay Option ARM
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Mortgage Loan Basics: Interest Only Loans and Pay Option ARM
Introduction
Understanding loans and mortgages begins with knowing loan limits. If your loan amount exceeds these limits, you will need a Jumbo Loan, which typically has a higher interest rate.
Loan Limits
- One-Family (single family homes): $417,000
- Two-Family (duplex): $533,850
- Three-Family (triplex): $645,300
- Four-Family (fourplex): $801,950
Fixed-Rate Loans
- 30-Year Fixed: Interest remains the same for 30 years. Ideal for long-term stays.
- 20-Year Fixed: Higher payments than a 30-year loan, but the interest rate is constant for 20 years.
- 15-Year Fixed: Offers higher monthly payments, suitable for those planning to sell within 5-8 years. The interest rate is fixed for 15 years.
Adjustable Rate Mortgage (ARM)
ARM loans have an initial fixed rate, then becomes adjustable. Here’s how they work:
1. Index and Margin: The loan's rate is based on an index (often LIBOR) plus a margin set by the lender.
2. Example - 5/1 ARM: Fixed for 5 years, then adjusts annually. The rate is the sum of the index and margin. For example, a 1-year treasury index at 4.18% with a 2.5% margin results in a 6th-year rate of 6.68%.
3. Caps: These protect against drastic rate increases. A 2/6 cap means no more than a 2% increase per period, and a total 6% increase overall.
4. Interest Only Option: Available with some ARM loans.
Different ARMs include 1/1, 3/1, 5/1, 7/1, and 10/1, each fixed for the initial years stated.
Interest Only Loans
These involve paying only the interest amount initially, which means payments are smaller but the principal balance doesn't decrease. They are often tied to indexes like MTA, COFI, or LIBOR.
Pay Option ARM Loans
These offer payment flexibility with four options:
1. Minimum Payment: Initial low payments can lead to negative amortization, where unpaid interest adds to the balance.
2. Interest Only Payment: Avoids deferred interest, stabilizing the loan balance.
3. Fully Amortizing 30-Year Payment: Gradually reduces principal.
4. Fully Amortizing 15-Year Payment: Accelerates principal reduction.
Negative amortization allows monthly payments below the interest rate, adding the difference to the loan balance.
Exotic Mortgages
1. 40-Year Mortgage: Extends the term, lowering monthly payments with higher interest than a 30-year loan.
2. Interest-Only Mortgage: Pay only interest for initial years, converting to a conventional mortgage later.
3. Negative Amortization Mortgage: Pay less than due interest, increasing the loan balance.
4. Piggyback Mortgage: Combines two loans to cover the property’s value, often to avoid PMI.
5. 103s and 107s: Loans that exceed the home's value, covering additional costs like closing fees.
6. Home Equity Line of Credit (HELOC): Functions as a credit line for purchasing homes, with tax-deductible interest.
In summary, understanding the nuances of various mortgage types can help you choose the most suitable option for your financial situation.
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