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Today I’ d like to discuss the controversial type of loan, which really is not so bad if you understand how it works. You probablly hear radio commercials about this.

Disclaimer: please not that I am explaining this as a consumer. So it is my advise that you consult with your bank of mortgage lendor for the exact details of this. This is only my single opinion about this. I like this loan. But there are also some people who have lost money, because of a lack of understanding of it. Always consult with a licenced lendor first, before you make any type of financial decissions.

Now here is my explaination of how this has worked for me:

As far as know: A true mortgage loan never has a 1 percent, 1.5 or 1.75 percent rate. So they call this a teasor rate for advertising purposes. Also this is only one option of payment when you use this type of loan. 

What you really get is a loan that is adjustable and it used the MTA or LIBOR index plus a margin of 2.75 percent. So the actual mortgage rate is currently at about 7.5 percent. This is actually pretty close to some regular fixed rates, but this is adjustable so it can go up or down each month.

When you apply for this loan and close: You are given a special option to pay a lower payment rate of lets say 1.5 percent of the interest only for a limited amount of years.

Afterwards you may have to make a higher payment. But this is usually after 5 years or more.

If the true interest rate is at 7.5 percent: Than the other 6 percent is it is actually taken away from your home equity each month. 

So you are actually creating some  negative equity with each payment.

And to explain this in another way you are given an option to make a much lower payment then you would if you had a regular mortgage. This is how some people are able to have super low mortgage payments. This works out excellent if you are in the business of buying homes and flipping them in 1 or 2 years. If you make a lot of equity gain, it will most probably ofset any losses.

Since the loan is called an option loan, you also have the option to make the full interest only payment or even a fully amortized payment. Sometimes they even give you an option to convert it over to a fixed rate. But you have to ask your bank or mortgage broker about this.

I have this type of loan and even though I may be creating some negative equity, my own home has increased in value by a much greater amount. I am also planning to start paying the full interest only payment later this year. Or I may sell my house and use my remaining equity to buy a smaller home for cash!

This is also an example of how you can leverage the banks money to build wealth via home equity much faster than you could ever save it in the bank.

This entry was posted on Thursday, February 8th, 2007 at 12:26 pm and is filed under Real Estate, Credit Loans, finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.