5/1 Interest Only Jumb ARM
The 5/1 interest only jumbo ARM is the type of loan that many borrowers used over the last five years to maximize the size of the mortgage available to them and, accordingly, the home price tag they could pay. It is also the reason that many borrowers are going to struggle to meet payments as they adjust over the next few years.
A 5/1 interest only jumbo is going to get you into a deluxe house - the question is, will you be able to afford it in year six? For the first five years of this loan, you will be paying interest only. On the sixth year, you will begin to pay a higher interest rate and you will have twenty five years left on your thirty year loan to pay off 100% of the sale price.
Here's a look at some hypothetical figures. Since the median home price in San Mateo County California is about $700,000 opt for a modest condo at $600,000 and scrape together (or borrow) the 20% down payment of $120,000. Setting aside the implausibility of that notion for a moment, go ahead and borrow $500,000 with an interest only 5/1 jumbo ARM. You'll need that extra cash for closing costs. Today (in May of 2007) the average interest rate available on a 5/1 interest only jumbo is 5.94% - which results in an initial payment of $2475. Assuming your mortgage index is the one year T-bill (today at 4.90%) and your margin is 2.50%, your interest rate in year six will be 7.4% and your monthly payments will commence at $3662.
That's an increase in your monthly payment of nearly 50%. After the initial adjustment your annual increases will be capped so the shock value will be reduced from year to year. But generally speaking, people who have used a 5/1 interest only ARM simply to get into the real estate market assume that they will be able to refinance by year six or they intend to sell the home. That was a reasonable assumption while the real estate market went through its protracted run-up in home valuation, but it is not as reasonable today.
For some people who foresee a rapid rise in household income over the next five years, a loan like this makes sense. If the real estate market is continuing to rise in your area, perhaps the home is an investment that can be sold in five years for a profit. And for those who simply want the most expensive home possible and are willing to roll the dice on the question of keeping it, the 5/1 interest only ARM will accomplish their goal nicely.