When the time comes to buy a house, coming up with the mortgage payment each month may be difficult now. However, if you anticipate your income will increase over the next few years, pick-a-payment mortgages provide multiple options for you to choose from when it comes to how you pay off your house.
Pick-a-payment mortgage options are adjustable rate mortgages. Choosing this payment plan gives you four payment options. You can make the minimum payment, which falls short of covering the total interest payment. You can make an interest-only payment. You can make a "regular" payment, which will include the interest and some of the principal and is designed to pay the mortgage off in 30 years. Or, you can choose to pay a larger than normal payment and pay the mortgage off in 15 years.
What It Means
The regular and the larger payments do not have any surprises attached because they put money toward the principal and the interest each month until the mortgage is paid. However, the other two options require catching up later. Choosing interest-only payments allows you to pay only the interest on the loan for a predetermined amount of time, then you must begin making larger payments on the principal and interest so you can catch up.
If you choose the minimum payment option, your payments won't even cover the entire cost of interest. These payments are structured to last for 12 months or 60 months. At that time, you will be required to begin making payments that will probably average 63 percent more than what your regular mortgage payment would have been, had you not opted for the minimum payment program. In addition, because your minimum payments do not pay the entire interest on the loan, the balance will continue to climb. If the balance reaches 110 to 125 percent of the starting principal, you will be expected to start making the larger payments, even if you have not passed the five-year mark. This option is used by borrowers who anticipate an income increase before the threshold hits. If you choose the 12-month minimum payment, you will pay 1 percent of the mortgage payment for the first year. If you choose the five-year minimum plan, the payment will be 1.9 percent of the mortgage payment each month for 60 months.
The primary advantage to the pick-a-payment plan is the ability to maximize cash flow and to control tax deductions for the first year or five years. Borrowers choosing pick-a-payment plans and using the minimum payment option might have other investments they want to put their cash toward. They may have other properties they need to sell to get out from under multiple mortgages before making full payments on the newest one.
Choosing to make minimum payments can leave you in financial stress if you encounter money issues at the same time you are supposed to increase your payments. Putting money away in savings each month or making sure your investment cash is accessible can help protect you against this occurring.
Candace Webb has been writing professionally since 1989. She has worked as a full-time journalist as well as contributed to metropolitan newspapers including the "Tennessean." She has also worked on staff as an associate editor at the "Nashville Parent" magazine. Webb holds a Bachelor of Arts in journalism with a minor in business from San Jose State University.