What is a Negative Amortization Mortgage?
The term "negative amortization" refers to the potential for an increase in your loan size over time - in other words, reverse or "negative" amortization. These loan programs allow you to pay less that the full amount of the interest due on your mortgage. If you pay less than the full amount of interest due, the difference is added to your principle balance. A typical negative amortization loan has the potential of growing to 125% of it's original amount.
Negative amortization mortgages are sold as "Option ARMS", "Pay Option ARMS", "Pick-a-Pay" programs, and a variety of other names. The characteristic they share in common is a low payment rate, usually between 1% and 1.95%. This rate is not the true note rate; it is the rate that your payment is based on. The true note rate is a market rate, or "fully indexed rate", and may be 5% or more above the payment rate.
If you are considering this loan type make sure you understand how it works. A good mortgage broker will take the time to communicate the details of this popular program. The low payment that this program offers is very attractive. But lenders give nothing for free. The low payment period will typically end after five years. Don't be caught unawares!
What is an Interest Only Mortgage?
Interest only loans allow you to pay only the interest due. The period of time that this interest only payment is allowed is typically limited to five, seven, or ten years. When the interest only period is past the loan is amortized over the remaining years. Ask your mortgage broker to explain the potential payment change that will occur at the end of the interest only period.
Unlike a negative amortization program, these loans do not increase in balance. The benefit is a smaller payment than you would make on a normally amortizing loan.
Most of these programs become an ARM (adjustable rate mortgage) at the end of the interest only period.
What is an ARM Mortgage?
There are hundreds of ARMs (adjustable rate mortgages) available today. The common feature is a periodic adjustment in your interest rate. That period may be as often as each month or as infrequently as every three years. There are three basic components to an ARM that determine how your interest rate moves.
When your rate changes periodically it will adjust to a sum of a moving "index" and a fixed "margin". The adjustment will be limited by "caps".
- Index - The index is a publicly available interest rate composite or average, maintained and published, normally, by a disinterested third party. Lenders think of the index as a reasonable representation of their cost of getting the money that they lend to you. The index changes at intervals reflecting changes in the economic environment.
- Margin - The margin is a number selected by the lender to be added to the margin in determining your interest rate. This number is fixed for the life of the loan.
- Caps - This refers to the maximum that your interest rate may increase a) at the first adjustment, b) at each adjustment thereafter, and c) for the life of the loan.
Before selecting an adjustable rate mortgage please take the time to review all of the numbers with your mortgage broker. At some point your interest rate will adjust. You don't want to be taken by surprise.
Any questions? Contact us. We are always happy to hear from you. 1-800-572-5964 - gmkeller@tds.net
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