Evaluating the Equity Effect

 

Contact Us Because your home is likely your most valuable financial asset, it's critical that you take steps to protect your investment. This is an important perspective to maintain now, when you might be tempted to focus only on the more immediate effects of a change in your monthly payment. While it's necessary to have a monthly payment that fits within your budget, it's equally important to pay some amount of the loan's outstanding balance - known as principal - each month. Your monthly mortgage payment consists of two components: principal and interest. Principal is the amount that reduces the outstanding loan balance Interest is the charge for using this borrowed money There are loans that permit borrowers to pay only the interest component - or just a portion of that monthly interest payment. However, they do not include the principal portion of your payment. Remember: Having a monthly payment that fits within your budget is only part of the equation. You also have to consider the long-term effect of your loan. Let's look at some of the effects of these loans. Loans that permit interest-only payments If you don't make principal payments, you lose the ability to automatically increase your home equity by decreasing your loan's outstanding balance. When the interest-only period expires, your payments can increase substantially because the remaining balance is repaid over a shorter period of time. For example, if you have a five-year interest-only loan, your principal is amortized over the remaining 25 years. If property values decline, you could owe more than your home is worth. Loans with payments that are less than your full monthly interest payment When your payments are less than the interest due each month, the unpaid interest is added to your loan's unpaid balance. When you repeatedly make monthly payments that don't cover the interest incurred each month, it's known as negative amortization because you're increasing the amount of your loan. Regularly making these minimum payments could result in owing more than your home is worth. When these loans - which are called option adjustable-rate mortgages (ARMs) - are adjusted, they typically increase to rates that are higher than traditional ARMs. How do you know if your mortgage is an interest-only or option ARM? Get your latest mortgage statement Use the information on your statement to answer this question: Is your outstanding balance higher or lower than the amount you originally borrowed? If your balance is lower than what you originally borrowed, you're building equity and adequately protecting this important financial asset. If your balance is higher or exactly the same, you should consider taking steps to protect your most-important asset by refinancing or paying an additional amount towards your principal each month. In most cases, interest-only or option ARM loans should be viewed as "transition mortgages." As soon as you can make a larger payment, consider refinancing into a loan that includes regular principal payments. If you have questions about your loan, our experienced mortgage consultants are always available. Next Topic: Considering Your Options Contact Us

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