There are many names for Negative Amortization Loans,
including Option ARM, COFI ARM and Deferred Interest ARM. Loans that
build negative amortization are usually tied to the COFI or MTA
index. They feature an adjustable interest rate.
Most Negative Amortization loans are advertised with
extremely low interest rates - also called "teaser" rates. The rate
may even be as low as 1%. The advertised 1% isn't really the
interest rate on the mortgage, it is simply the rate used to
calculate the minimum required payment for the first year. The
actual interest rate charged on the loan is equal to the index plus
the loan margin. The interest usually will adjust on a monthly
Negative Amortization loans come with three payment
Principal and Interest Payment - This payment includes
all interest due along with the amount of principal necessary to pay
the loan off over a 30-year period.
Interest-Only Payment - This payment
is only the interest due on the mortgage. When no principal is paid,
the outstanding balance remains unchanged.
Minimum Required Payment - This is
where the 1% comes in. The amount paid is actually less than the
interest due. The remaining interest is added to the principal
balance, which increases the outstanding balance on the mortgage.
You actually will owe more than what you borrowed. This is called
When the balance on the loan increases to 110% of the
original balance, the loan will convert to a fully amortizing
mortgage , which will be paid over a 30-year term. The borrower then
loses the options and is required to pay the principal and interest
payment for the rest of the mortgage.
The main thing to keep in mind is that whether you are
paying the interest due each month or adding it to your principal
through a minimum required payment, the interest rate you are being
charged is not 1%. The interest rate is equal to the index used plus
the margin. For example, a zero-point negative amortization loan may
have a Margin of 3.7 and follow the COFI index. If the index stands
at 3.655, the interest rate you are paying will be 3.7 plus 3.655.
That equals 7.355% interest rate.
Fixed/ARM loans are a more financially stable option
than a Negative Amortization loan. There are 3/1, 5/1, 7/1 and 10/1
options available. The first number is the years the loan is fixed,
while the second number is how often the interest rate adjusts. For
example, a 10/1 loan has a fixed interest rate for the first ten
years and then adjusts once a year for the remainder of the mortgage
Many lenders are also offering fixed/ARM loans with
options. You can choose to either pay the principal and interest
payment or an interest-only payment. There is no negative
amortization to worry about. Plus, many programs offer low initial
fixed interest rates and favorable terms.
Fixed-rate interest-only mortgage
gives the security of a fixed interest rate and the low monthly
payments in the early years. Borrowers are able to lock the interest
rate for the life of the loan. The interest-only period usually
lasts for the first 10 to 15 years.
With rates climbing to their highest levels in recent
years and the gap between short-term and long-term interest rates
closing, the demand for fixed-rate interest-only mortgages has
risen. The cost of adjustable mortgages, which are usually
associated with interest-only options, have climbed faster than the
rates for fixed mortgages.
These mortgages are not without drawbacks. Borrowers
who are only making interest payments on their homes aren't building
up any equity, apart from the increase in property values. Once the
interest-only period ends, the homeowners can be hit with sharply
higher monthly mortgage payments.
The savings may not be as great as you would expect.
Fixed-rate interest-only mortgages carry a higher interest rate than
the traditional 30-year mortgage. Also, the majority of the interest
is paid in the first years of the loan.
Fixed-rate interest-only mortgages are just the latest
in a long line of non-traditional mortgages designed to boost