How do you determine the actual interest rate on one of these loans? First of all these are straight variable loans which can have a new interest rate every month. The payment rate (1%) stays the same all year and then only goes up a little each year for the first five years. Remember THIS IS A PAYMENT RATE NOT AN INTEREST RATE!
All of these pay option loans, as you will find in all adjustable loans, have an index and a margin. The index is either the average yearly t-bill or a libor index ( one month, six months or one year.) Those are the two most popular indexes although there are several others. Every month that the index moves the interest rate moves. How much the rate moves is dependent on the margin.
The margin is a figure that you are assigned when you take the loan. An amazing margin is under 1% while a poor one is over 3% Although it is the borrowers decision on what index and what margin they choose, most do not know either term and never seem to have or even want a part in what determines their interest rate. This has to stop if the borrowers in this country want to improve their financial position. Just because you are told this is the best loan for you doesn't mean that it is. Investigate it. Learn before you're burned.
And now we will discuss Interest Only loans which are, in my opinion, good loans that have been tarnished by the negatively amortizing pay option arms. Interest only is really an option not a loan. Just because it says interest only for five or ten years doesn't mean you have to ever pay even one month as interest only (just the interest, none of the principal). You cannot ever go negative on a interest only loan because you must pay the interest due each and every month!
There are several things I like about the interest only loans. The first is that as a self employed or commission sales person you can keep your payments low for the majority of the time, and then, when you get a good check, you can pay down on the principal. Once that happens your interest only payment is lowered because the principal of the loan is lower. This works for bonuses as well obviously. The other point is that if you run into a bad period, you can pay interest only until things turn around. That is a worthwhile option to have in your back pocket!
The mortgage industry is getting more complex as new products are introduced to the market. For the vast majority of American borrowers, this is your biggest liability. Take time to learn about the industry and do more for yourself than just calling different companies and asking about their rates. Learn the ins and outs of the products so you can find what works for you. As always, I am just an email away.