February 18, 2011
When a first-time home buyer is searching for a home to buy with an FHA guaranteed loan, the buyer isn’t just shopping for a home–they’re also shopping for a home loan. There are many options to choose from, one of which is the adjustable rate mortgage or ARM loan for short. Another is the interest-only mortgage loan, also known as an I-O mortgage.
We’ve covered FHA ARM loans in previous blog posts, and there is plenty of information available on interest-only loans…but what are the important milestones in an ARM loan or I-O mortgage an FHA borrower should know?
The first and most obvious is the introductory period where the lowest interest rate applies. These periods are used to make the loan as attractive as possible. According to the FDIC official site, “Many option ARMs have a 1-month or 3-month introductory period at the beginning of the loan. During this period, lenders use a lower interest rate to calculate your payments. For some I-O mortgage payment loans, this introductory period lasts 1, 3, or 5 years.”
After the introductory rate, FHA ARM and FHA insured interest-only mortgages have an interest rate adjustment period. When the interest rates begin to change, your minimum monthly payment may not increase right away. But any lack of increase in the monthly FHA mortgage payment doesn’t change the fact that the money is owed.
Smart borrowers factor in the additional interest rate and increase their monthly payments to ward off negative amortization.
Eventually, there will be mortgage payment adjustments. The FDIC says, “Most I-O payment mortgages and payment-option ARMs have payments that adjust once a year. In addition, most of the adjustments on payment-option ARMs are limited by a payment cap, usually 7.5%. Keep in mind that payment caps do not apply when your loan is recalculated at the normal recalculation period.”
The payment cap sounds appealing, but the FDIC warns, “Payment caps also do not apply if your balance grows beyond 110% or 125% of your original mortgage amount.” That is one reason why it’s so important to avoid negative amortization–when the amount you’re paying doesn’t keep up with the interest rate changes.
There’s also another critical milestone, the recalculation period, which we’ll cover in another blog post. Until then, it’s very important for borrowers considering FHA insured ARM loans or interest only payments to carefully examine the details related to interest rate adjustments, negative amortization risks and other important factors. FHA loan applicants should never make assumptions about any loan–it’s vital to do plenty of research, ask a lot of questions and choose the right loan product for you.
Bruce Reichstein has spent over three decades as an experienced FHA and VA home loan mortgage banker and underwriter where he was responsible for funding “Billions” in government backed mortgage loans. He is the Managing Editor for FHANewsblog.com where he educates homeowners on the specific guidelines for obtaining FHA guaranteed home loans.
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