If you and your significant other are shopping for a home loan, you might come across a 5/25 mortgage as one of your options. This loan offers a low, fixed interest rate for the first five years, but requires you to pay off the remaining balance or refinance at the end of five years. Understand some of the characteristics of a 5/25 mortgage to determine if it fits your situation.
Initial Interest Rate and Payments
The monthly payments on a 5/25 mortgage are calculated as if the loan was a 30-year fixed-rate loan. The initial interest rate is typically lower than the market rate on a 30-year fixed mortgage because the lender is committing to a fixed rate for only the first five years. For example, the rate on a 30-year fixed mortgage might be 6 percent, while the initial rate on a 5/25 might be 5 percent, which would result in a lower payment.
A 5/25 mortgage is also known as a balloon mortgage because of the large size of the remaining balance that comes due at the end of five years. For example, if you have a $200,000 remaining balance at the end of five years, you would owe the lender a $200,000 balloon payment. A lender typically gives you an option to avoid forking over such a large amount of cash by allowing you to refinance for another 25 years.
If you choose to refinance at the end of five years, you would get a new fixed rate and payment based on market rates at that time. Some 5/25 mortgages might allow you to convert to an adjustable-rate mortgage, which means your rate and payment would change periodically for the remaining 25 years. The lender might require you to meet certain conditions to qualify to refinance, such as having a good payment history and continuing to live in the home.
You may benefit from the initial low rate and payments of a 5/25 mortgage, but there is some risk involved. If you don’t qualify to refinance at the end of five years, you would be responsible for the balloon payment. If you qualify to refinance, you might get stuck with a higher rate and payment. Terms of a 5/25 mortgage can vary between lenders. Ask your lender plenty of questions to fully understand the terms of the 5/25 mortgage being offered.
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