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 basis. '

Negative Amortization loans come with three payment options:

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 negative amortization.

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 term.

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 affordability.