Negative Amortization Mortgages or Deferred Interest Loans might be smarter than you
realize, this website will explain all the details....
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Deferred Interest Mortgages have out performed fixed
rates over the last 16 years, even
if you had refinanced 3 times during each interest
rate downturn. This is a powerful
fact that is lost on some people who don't understand
the smart financial sense these loans have proven to
make. We will explain the details of what
make these loans tick.
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Adjustable rate mortgages with potential for deferred
interest, sometimes referred to as negative amortization
mortgages, deferred interest mortgages, or neg-am
mortgages are probably the most widely misunderstood, and
emotionally charged loan products available today.
Many mortgage professionals don’t understand the
full benefits of a loan with potential for negative
amortization, or deferred interest, or still remember the
horror stories of the old adjustable rate mortgages
without interest rate caps, so they are unable to educate
the client on the details and benefits of these particular
loans. Here we will explore the nuts and bolts of a
“neg-am loan”, the many benefits, along with the few
drawbacks, simple, straightforward - with no smoke and
mirrors. We will see why a loan with the potential for
"negative amortization" may make the most sense
for you, even if you currently have a low fixed rate.
First of all you need to remember that most loans with
potential for negative amortization only go negative if
you let them (you normally have four monthly payment
options), and the maximum your loan balance can ever go up
even if you make the minimum payment is usually only 110%.
It's what you do with the deferred interest savings
when you choose the lowest payment option that makes the
difference.
Let's take a hard look at these types of
loans. How does a loan with potential for “negative
amortization” or “deferred interest” work? There are several factors that make up all adjustable rate
mortgages, they are; the start
rate, the effective
rate, the index, the margin, and
the life cap and/or
payment cap. The start
rate is what your starting payment is based on, your
payment is usually fixed for a year and can not increase
more than 7.5% per year; for instance if your
payment was $1000.00 a month, the most it could go up in
one year would be 7.5% or only $75.00.
The effective
rate on all adjustable mortgages is determined by adding
the index to the margin.
The margin always stays the same and the index can
fluctuate.
The difference between a conventional adjustable
rate mortgage and one with potential for negative
amortization is the neg-am mortgage has an annual payment
cap along with a lifetime cap.
This means that no matter what the market does the
most your payment can ever go up in one year is only 7.5%;
whereas with a conventional adjustable rate mortgage they
do not have a payment cap each year only an interest
rate cap, so your payments are at the mercy of the
market.
With a mortgage with potential for deferred
interest you typically have four different payment options
each month: the minimum deferred interest payment, an
interest only payment, a payment that fully amortizes the
loan in either 30 or 40 years, and a payment that fully
amortizes the loan in 15 years. Sometimes the minimum payment on a negative
amortization mortgage is not enough to fully amortize the
loan. The amount of deferred interest or negative
amortization is the difference between the interest only
payment and the minimum payment.
EXAMPLE:
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Typical
Deferred Interest
Mortgage
Loan
Amount = $275,000
Start Rate = 3.95
Index = 2.002 (actual as of 1-15-03)
Margin = 2.200
Effective rate = 4.202
(actual as of 1-15-03)
Life Cap = 9.9%
(*index would have to go to 7.7%)
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Different
Monthly Payment Options
Min.
payment. based on
start
rate = $1140.79
Interest only pmnt. = $962.96
15
yr. payment = $2027.25
30 yr. payment = $1304.97
Maximum
deferred interest:
=
177.83
positive*
*based
on today’s market (1-15-03) there is actually no
chance of this going negative, since the difference
between the minimum payment and the interest only
payment is not a negative number.
This is a perfect example of how these loans
are guaranteed to pay off on time.
It also illustrates why they have out
performed fixed rates over the last 15 years, even
if you had refinanced 3 times during each interest
rate downturn.
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1.
What is the difference between the most popular indices?
There
are two types of indices: cost
driven, and market
driven. Some examples of market driven indices
are CD's, Libor, and Prime Rate. Some examples of
cost driven indices are The 11th District cost of funds or
COFI as it is commonly called, the MTA or Monthly Treasury
Average, and the Cost of Savings Index or COSI for short.
Historically market driven indices have been more
volatile, for example the Japanese own almost as many
T-Bills as the USA, just think what would happen to that
index if they were to ever sell? On the other
hand the cost driven indices have built in mechanisms to
keep them low, for instance:
The Cost of funds index, or COFI is the weighted average
cost of money to the San Francisco Federal Reserve, which
is in the 11th district out of a total of 12 districts in
the U.S. The money for most 11th district loans comes from
deposits made by customers. The Savings & Loans which make the majority of
these loans like to match the interest rate on the loan to
the interest rate they have to pay to their customers; of
course they want to keep that rate down as low as
possible.
The Monthly Treasury Average or MTA is based on the
average annual monthly yields of U.S. Treasury Securities,
adjusted to a constant maturity of one year, as made
available by the Federal Reserve. This index is
determined by adding together the monthly yields for the
most recent 12 months and dividing by 12. Because it's an average, higher yields in some
months are offset by lower yields in others. It's
considered one of the soundest choices for home
investment, since interest rate increases take longer to
affect the 12-month MTA than other ARM indices.
The COSI index is the monthly weighted annualized rate
paid out on all deposits taken in by Golden West
Financial, a 40 billion dollar company, of course they
want to keep that rate down as low as possible as well.
*Ask to see a 10-year history of these indices:
click here for info >>> COFI index, MTA
index, COSI index
2. Why would I want a loan where the balance can go
up?
It depends on what you do with the savings from the deferred
interest. If you go to Vegas and blow it, then it
may not make financial sense for you; but if
you apply the difference you would be paying on a
conventional loan to high interest credit cards, or put it
into a savings vehicle such as a 401k (especially
if it's matched by your employer) or mutual funds etc,
you'll be amazed at how much smarter this type of loan is
compared to a fixed rate or a conventional adjustable.
Even better if you combine this with an automatically
deducted bi-weekly payment you'll be able to pay off your
home probably in half the time you thought. Let
one of our professional loan consultants do a no
obligation loan analysis.
3.
How will I ever pay off my loan if deferred interest is
making the balance go up?
Your neg-am adjustable is designed to pay off on time.
It's guaranteed. While there are occasions when
deferred interest can add to your loan balance, there are
many other periods when your loan pays off faster than the
normal rate. Over time these periods of deferred
interest and faster payoff offset each other. The
result: your mortgage pays off on schedule.
Your loan has a deferred interest payment option that
offers you four different payment choices that are clearly
marked on your monthly payment coupon. These choices
are fifteen year fully amortized, thirty or forty year
fully amortized, interest only, and a deferred interest
option.
4. What Are The Advantages And Disadvantages Of Negatively Amortized
Loans?
There is not a clear understanding of the advantages and
disadvantages of negatively amortized loans amongst
consumers. A negatively amortized loan is not good or bad in
itself - that depends on the consumers’ needs and
preferences. It is important to understand the advantages and
disadvantages of these loans - prior to judging them. All Neg-am loans have a lifetime interest-rate cap,
which is the maximum the interest rate can ever go to. Some people have a misconception that the maximum
interest rate can go higher than the life cap, however this is not true. There are no monthly or annual caps on the interest
rate. This is because there are no caps on the checking, savings, CD& money market accounts that the money is coming from. Even though there are no interest-rate caps, a
quick look at the 15-year history of the most popular indices such as the COFI, MTA, or the COSI will show that
it normally changes less than 2% in a year. If the interest rate increases and the minimum
payment does not increase sufficiently then the payment
does not cover the interest payment causing the loan
balance to increase slightly. However, the customer can always pay a fully
amortizing payment based on the current interest rate to
keep the loan non-negative.
In summary the main disadvantage of a negatively amortized
loan is that you can lose equity if you make the minimum
payment and don’t apply what would be the difference of
the fully amortized payment to an investment vehicle, or
credit card with a rate higher than the effective rate
(usually a no-brainer). This loan can also be a bad choice if you want to
build equity in your property but do not have the
discipline to manage your money. The advantages of this type of loan are many, such
as:
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·
the absolute lowest payments available
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payment flexibility
·
make high or low payments
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maximize your cash flow
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·
buy more home with lower qualifying ratios
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easier qualifying
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less than perfect credit ok
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40 year loan terms available
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This
loan can be good choice for first time homebuyers wanting
to maximize what they can afford, or for self-employed
borrowers whose incomes may vary month to month.
It can also be a good loan for rental properties
because the payment flexibility can be used to avoid
negative cash flow.
If
you have ANY questions regarding these types of loans
please don’t hesitate to contact one of our deferred
interest loan experts to have them explain the details as
it relates to your own situation.
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