INTEREST ONLY
LOAN
An Interest only can be
an excellent choice for some borrowers. They are
designed to offer the lowest payment possible as you are
not paying anything toward the principal in your normal
monthly payment. Because of the lower payment, the
interest only loan may mean that you can buy more home
than with a fully amortizing mortgage. Of course, you
may make additional payments toward your principal
balance at any time.
The product was designed
for individuals whose income is cyclical. For example,
an individual who is a sales executive with a relatively
low base salary but commission or bonus payouts
quarterly would benefit from an interest only mortgage.
You would have the lowest possible payment during months
when no bonus is paid and you would be able to make
contributions to the principal balance when the
quarterly bonus is paid.
For example, if a 30-year fixed-rate
loan of $100,000 at 8.5% is interest only, the payment
is .085/12 times $100,000, or $708.34. This is an
example of interest only payment.
Each loan payment consists of
Interest and Principal. Here you will be paying an
interest each month and your principal will be adding to
your balance, thus increasing it. You may also pay
both principal and interest.
Interest only Loans have these
options:
1) Index:
CMT-MTA-COFI-CODI-COSI-LIBOR-Prime Rate
2) Margin: Is given to you by your
lender, and it is the difference between the index rate
and the interest charged to the borrower
For example 5/1 ARM. This loan is
fixed for 5 years after which in 6th year it becomes an
adjustable loan. Your loan officer will tell you
what your index is and what your margin is. Usually 5/1
arm is tied to 1-year treasury index and margin is
around 2.00%-3.00%
Your index + margin = Fully Index
rate . Your new note rate (interest rate) after 5th
year.
What about the 6th year? What would
your payment be?
Let's say that your loan officer
told you that your margin is 2.5% with 1 year treasury
index. You will have to look up 1 year treasury index
for a specific month.
1 year treasury as of Oct.2005 is
4.18, and you know that your margin is 2.5%. Therefore
you new interest rate is 1 year treasury
4.18% (index) + 2.5% (margin) = 6.68% for the
beginning of 6th year.
Index rate are move on monthly
basis, therefore your payment may fluctuate each month.
In most cases banks wills end you a statement advising
you that your rate will change.
3) To protect consumers from high
index rates, lenders implemented a CAPS.
An example of this is a 2/6 cap,
which allows the interest rate on your ARM loan to go up
or down by no more than two percent every adjustment
period, and has a total limit of six percent for
cumulative changes. Therefore a 2/6 cap on a 5% ARM will
allow a maximum rate (6 + 5%) of no more than
11%.
In some cases you will see 2/2/6,
which means 2% adjustment with 2 year prepayment penalty
and total of six percent of cumulative
changes.
Equal Housing
Opportunity (c)
Copyright 2006 #1 American Financial
(1AmericanFinancial.com)