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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.

Analyzing APR during mortgage refinancing or second mortgage loan shopping can be a very tricky proposition. Many people have come to believe that a loans APR, or “Annual Percentage Rate”, is the single most important factor in comparing mortgage loans. However, this is rarely the case, especially in today’s marketplace, explains Bob Peckenpaugh, Manager of CFIC Home Mortgage.

Annual Percentage Rate is defined as “the cost of consumer credit as a percentage spread out over the term of the loan. Most consumers have no idea what makes up this elusive number. APR is a valuable tool in comparing various mortgage loan programs, but it should never be relied upon as the sole determining factor in choosing a loan, for the following reasons:

1) Not all closing costs are calculated within the APR uniformly. According to Peckenpaugh, There is a huge variance among lenders, mortgage loan officers, and even states on which fees they include in their APR when calculating the loan. There is no standard among the mortgage industry, let alone among competing mortgage companies.

2) The costs themselves can be manipulated within the loan. For example, prepaid interest (the amount of pro-rated interest a consumer pays at closing for interest which will be earned from that date until the end of the month) can be represented as anywhere from 1 to 30 days, a potentially huge difference, especially on larger mortgage refinancing loans.

3) Manipulation of the title fees. Ordinarily, the title company’s settlement, or closing fee is an APR fee, while their title insurance cost is not. Peckenpaugh explains, Recently, in order to minimize the effect to the APR, title companies began simply decreasing their closing fee, while subsequently increasing their title insurance fee by the same amount, thereby reducing the APR.

4) Lack of industry awareness of what is accurate. Most mortgage loan or refinancing officers do not intentionally try to mislead, but inaccurate information could result in the consumer making a poor decision.

As opposed to APR, consumers would be better served by asking the following simple questions.

1) What is the mortgage interest rate?
2) What is the total mortgage loan amount?
3) What is the monthly mortgage payment (principal and interest)?
4) How much are the closing costs?

Generally, a written estimate covering all of the above can be generated by the mortgage loan-refinancing officer and provided to you in the form of a “Good Faith Estimate” and/or a “Truth In Lending Statement”. Then, you can compare these documents between mortgage lenders in order to determine the authenticity and accuracy of your quotes. For further mortgage financing or refinancing information, contact Bob Peckenpaugh, Manager, CFIC Home Mortgage, at 1-800-943-9472.

Over the last few years, thousands and thousands of homeowners have financed or refinanced their homes with ARM’s, Adjustable Rate Mortgages.

ARM’s are mortgages that are tied in to lower interest rates in the beginning so that many homeowners can afford their monthly payments. As long as interest rates stay even or go lower, the home owner is fine. The danger comes when interest rates start to rise. Monthly payments can go up hundreds of dollars when the interest rate/payment terms come into effect.

That danger is now. Interest rates have been going up as The Federal Reserve has raised rates for the 15th time in the last two years. And, it doesn’t look like rates are going to stop going higher anytime soon. As these mortgages reset to higher rates and payments, many of these ARM homeowners are going to be in a financial bind. Many may even lose their homes.

According to the Mortgage Bankers Association at the end of 2005, some states such as Michigan, Missouri, Tennessee and Alabama have as many as 20% of the ARM homeowners behind by thirty days or more. Foreclosure proceedings usually start when a homeowner is ninety days late. Hopefully, these homeowners will get refinanced before it is too late.

If you have an ARM, you should look at your finances to be sure you will remain solvent in these upcoming times. How high can your monthly house payment go? Will you be able to afford it? Talk to a financial adviser and determine if refinancing to a fixed rate is the best way for you to go. I believe locking in a fixed rate is the safest decision you could make at this moment in time.

There are many mortgage companies that will look to provide refinancing options for you. Unfortunately, many of these companies may be much more stringent in regards to your credit worthiness. That is, it may be much harder to borrow that money now than when you initially purchased your first or second mortgage. You will never know unless you try and the clock is ticking.