What it is:
An interest-only mortgage in which the borrower only pays the interest on the for a set period.is a
How it works/Example:
In general, an interest-only prime rate, but sometimes , the one-year constant-maturity Treasury, or other benchmarks) plus an additional spread (which is also called the , and its size is often based on the borrower's credit score). The plus the spread equals the interest rate on the ; it is called the fully indexed rate. Some ARMs a discounted rate, also called a teaser rate, during the first or so.
To understand how interest-only affect a borrower's payment, let's assume that a bank offers a $100,000 to a potential borrower at 8%. The monthly payment would be $733.77 -- of which $666.67 is interest and $67.10 of which is of the original $100,000 amount. But in an interest-only , the payment is only the interest portion: $666.67. This reduces the borrower's payment, but it leaves the outstanding (and accruing more interest).
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If the interest rate is variable and the interest rate goes to, say, 9%, the interest-only payment goes to $750. In many cases, adjustable-rate have caps--limits on how high and sometimes how low the interest rate can go, and how much they can move in any one , month, or quarter. In some cases, the interest rate adjust only upward -- that is, borrowers get no benefit if interest rates fall.
Why it matters:
Interest-only mortgages are risky temptations and generally a bad idea. The typical strategy behind taking an interest-only
Interest-only can have complex implications. Thus, as is the case with any or other , borrowers must be sure to read and understand the 's documentation and contemplate the implications of changes in interest rates. Borrowers should be sure they can handle the worst-case scenario of being forced to make the higher payments once they begin repaying the . In adjustable-rate mortgages, are legally required to disclose how high the borrower's monthly payment might go, and that the original is just going to keep accruing interest until it is paid.