Question: |
What are the risks with interest-only (I-O) mortgage payments and payment-option ARMs? |
Category: |
Business & Finance > Renting & Real Estate |
Keywords: |
risk, interest-only, I-O, interest, only, payment, option, payment-option, mortgage, loan, ARM |
Type: |
what |
Rating: (0 ratings) Views: 232 Discussions: 0 In Watch Lists: 1 |
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Answer:
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Risks with Interest-Only mortgage payments and payment-option ARMs:
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Rising monthly payments and payment shock. It is risky to focus only on your ability to make I-O or minimum payments, because you will eventually have to pay all of the interest and some of the principal each month. When that happens, the payment could increase a lot, leading to payment shock.
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Negative amortization. If you have a payment-option ARM and make only minimum payments that do not include all of the interest due, the unpaid interest is added to the principal on your mortgage, and you will owe more than you originally borrowed. And if your loan balance grows to the contract limit, your monthly payments would go up.
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Refinancing your mortgage. You may be able to avoid payment shock and higher monthly payments by refinancing your mortgage. But no one knows what interest rates will be in 3, 5, or 10 years. And if your loan balance is greater than the value of your home, you may not be able to refinance.
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Prepayment penalties. Some mortgages, including I-O mortgages and payment-option ARMs, have prepayment penalties. So if you refinance your loan during the prepayment penalty period, you could owe additional fees or a penalty. Most mortgages let you make extra, additional principal payments with your monthly payment. This is not considered "prepayment," and there usually is no penalty for these extra amounts.
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Falling housing prices. If housing prices fall, your home may not be worth as much as you owe on the mortgage. Even if home prices stay the same, if you have negative amortization, you may owe more on your mortgage than you could get from selling your home. Also, you may find it difficult to refinance. And if you decide to sell, you may owe the lender more than the amount you receive from the buyer.
Source: Federal Reserve Board
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What are the risks with interest-only (I-O) mortgage payments and payment-option ARMs?
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