Free Investment Advice

When you take out a loan or buy merchandise with a credit card, the payments you make each month are paid against the principal of the loan and the interest accrued.  For refinancing mortgages, the same holds true - with one exception.

If you decide on an interest-only option payment plan, you pay the interest only for a specific number of years.  Subsequently, repayment of both the principal and interest is required.  Note, however, that interest-only options typically apply to adjustable mortgage rates.

According to the Federal Reserve Board, here is how a typical interest-only option works:

“An interest-only (I-O) ARM payment plan allows you to pay only the interest for a specified number of years, typically between 3 and 10 years. This allows you to have smaller monthly payments for a period of time.  After that, your monthly payment will increase - even if interest rates stay the same - because you must start paying back the principal as well as the interest each month.  For some I-O loans, the interest rate adjusts during the I-O period as well.

For example, if you take out a 30-year mortgage loan with a 5-year I-O payment period, you can pay only interest for 5 years and then you must pay both the principal and interest over the next 25 years.  Because you begin to pay back the principal, your payments increase after year 5, even if the rate stays the same.  Keep in mind that the longer the I-O period, the higher your monthly payments will be after the I-O period ends.”

For added protection, according to the Federal Reserve, it is also important that you:

“…receive information in writing about each ARM program you are interested in before you have paid a non-refundable fee.  It is important that you read this information and ask the lender or broker about anything you don’t understand - index rates, margins, caps, and other ARM features such as negative amortization.  After you have applied for a loan, you will get more information from the lender about your loan, including the APR, a payment schedule, and whether the loan has a prepayment penalty.”