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Danger of Deferred Interest Mortgages: Understanding the Risks of Negative

Danger of Deferred Interest Mortgages: Understanding the Risks of Negative Amortization Home Loans

Negative amortization or “neg am” occurs when the minimum payment on a mortgage covers less than the monthly interest charged, causing the balance of the loan to increase instead of decrease. Interest only loans generally dont increase the balance due on a home although they dont diminish the amount due. However, deferred interest loans will increase your loan amount. This can happen with negative amortizations loans like a payment option ARM, where payment choices can be calculated based on COFI – The 11th District Cost of Funds Index which demonstrates the average interest rate paid by certain banks in Arizona, California and Nevada or on MTA – The 12 month Treasury Average, giving you a variety of choices in payments. While these loans can be a good deal when short-term interest rates are low, they are not necessarily the right choice when short term loans have a higher interest rate, like now. For most, now is not the right time to refinance a fixed-rate loan for a deferred interest mortgage.

If you are looking to eventually cash out home equity, you should look for a purchase loan that involves paying some of the principal. Not only is it possible you may not build equity in your home with neg am loans, but you also may have a loss of equity through an increased mortgage balance. If you suddenly need to sell your home, you may not be able to get a purchase price high enough to cover your loan. You will also have more difficulty getting a second mortgage behind negative ARM loans.

Henry Savage, president of PMC Mortgage notes that on a deferred mortgage, The mortgage balance can increase as much as 350 per month for every 100,000 that’s borrowed. The neg am on a 500,000 loan for example, can be as much as 1,750 per month. He continues by noting, There are not many circumstances where I would recommend an Option ARM. However, there are a few instances where deferred interest or negative amortization loans may make sense.

Neg am loans are good for investment properties when you may be paying a double mortgage. They are also good for self-employed with cash flow issues. If you plan on normally paying some of the principal, but dont know what your cash flow will be like from month to month, it may be helpful to have the option of a minimum payment.

Do you homework before deciding on a deferred interest mortgage. Although your payments will be lower, there are inherent risks involved and you may be better off with a fixed-rate mortgage.

Adjustable Rate Mortgages Interest Rate Strategy

Over the last few years, many people squeezed into new homes using adjustable rate mortgages. With interest rates going up, you now need a new interest rate strategy

Adjustable Rate Mortgages ARMs

Adjustable rate mortgages carry a bit of a gamble for home owners. Essentially, you trade smaller interest rates and lower initial payments on the gamble rates will not increase over time. If rates stay low, you make out like a bandit. If rates increase, you need to consider your options to avoid getting stuck with a high interest rate loan and resulting cash flow problems from increased monthly mortgage payments.

For the last three or four years, adjustable rate mortgages have been offered with incredibly low interest rates. Many people used these low, low, low rates to buy homes that would otherwise be beyond their means. Starting in 2004, Federal Reserve Chairman Alan Greenspan started making noises about increasing money borrowing rates. He has followed through on these hints. Although mortgage rates arent tied directly to the Federal Reserve Bank, they are heavily influenced by it. As a result, many people are now facing tight finances.

Avoid Rising Rates

There are really only two solutions for avoiding the increase in interest rates on adjustable rate mortgages. The first strategy is to immediately convert to a fixed rate mortgage product. Fixed rates are still at historic lows when compared to rates offered over the last 50 years. By flipping to a fixed rate, you will be able to solidify your budget and finances since you will know exactly what you have to pay each month. If rates decrease in the future, you can always try to flip back to an adjustable mortgage loan.

Unfortunately, some home owners are simply going to have to face the fact they lost one the interest rate gamble. Typically, this will occur when you realize you simply cant afford to make the monthly payments required by getting a fixed rate loan. In such a situation, you are going to have to sell your home and downsize. In most situations, it is better to do this now since youve probably built up a sizeable chunk of equity over the last few years and want to avoid a loss of that equity as the market cools down. While this may sound like a disaster, it really isnt. Yes, you have to downsize, but you should still have built up a chunk of equity.

Interest rates are going up whether you want to acknowledge it or not. The time to deal with your adjustable rate mortgage is now, not when you straining to make payments.