Scenario: I have been recently approved for a 2/28 ARM with 5 year interest-only period and received a commitment letter. I filed bankruptcy 3 years ago but my spouse, the co-borrower has good credit, about 730. The mortgage company said the loan would adjust every 6 months. But I expected to handle this loan only for 5 years as I would pay off the car within the next 2 years. Also within the next 5 years, the bankruptcy could be erased from my credit report. Another company has offered me a 30 year fixed rate loan with 5 year interest-only payment plan. I’m trying to build up equity and refinance into a 5 year with a low rate. I’d like to know more about what I can qualify for and build up equity.

Solution: A 2/28 year ARM is an adjustable rate mortgage which offers a fixed rate of interest for the first 2 years after which the rate adjusts itself. If this loan program comes along with a 5 year interest-only option, then the first 2 years may be great because there’ll be no rate increase during that time period. At the end of 2 years, you may get a rate increase of 3-4% and after 2 and 1/2 years (due to rate adjustment every 6 months) there can be another rate increase probabarticloly by 1%. After 5 years, there will be considerable increase in your payments because then you’ll have to pay the principal also.

The 2/28 year adjustable rate loan with 5 year interest-only option allows you to pay less on a monthly basis. But this doesn’t help you build equity as because there’s no payment towards the principal for the first 5 years. Moreover, rates would start adjusting at the end of 2 years. So, it’s important to know about the Indexed Rate attached to your loan, the margin and the rate cap. Then calculate your payments using a mortgage calculator. This will help you decide whether you can afford to manage the 2/28 ARM.

Apart from a 2/28 ARM, there are various loan programs you can opt for. What you need to do is keep looking for such programs with different lenders. Since you have a bankruptcy filed 3 years ago, I feel it will be better if you go for stable monthly payments including the principal and interest. Not that it has to be a 30 year fixed rate loan. Even a 5 year fixed may suit your situation. And, I do feel a fully amortized loan would work well for you because if you go for an interest-only option just to qualify for a mortgage, it will be similar to leasing the home while having the liability to pay for repairs.

However, if building up equity isn’t your priority right now, then you can apply for a 30 year fixed rate 5 year Interest-only loan. Such an option has only 1 payment adjustment as compared to that of the 2/28 adjustable rate mortgage. The interest rate on a 30 year fixed 5 year Interest-only loan may be only 1/2 % lower than that of the Introductory Rate of the ARM. So, I suggest that you go for a 30 year fixed 5 year Interest-only option. And after you’ve paid your car off in the next 2 years, you can start paying towards the principal from the 3rd year itself. Most lenders accept payments towards the principal even during the interest-only period. And if you can do so, you’ll be able to build up equity faster.