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Negative Amortization & Interest Only Loans
There is a
common misperception that all interest only loans have a feature called
negative amortization. If you think this then you need to read the
following because most
interest-only loan programs that are available with short term fixed
rates DO NOT have negative amortization.
Many loan officers are learning interest-only
programs for the very first time and one of the most popular programs
over the past few years has been what's known as the Option Arm or MTA loan.
These loans are advertised with rates as low as 1.00%. First of all, these loans contain the possibility of
negative amortization (which common libor loans almost never) and if you
are financing above 90% of the value of your home it is almost impossible to secure a second mortgage
or home equity loan. If you do, your rate will be something which
will make you think about reconsidering your first mortgage.
The good news is that almost all LIBOR loans do not
have this feature. If you hear a loan officer explaining a program
with a rate that's too good to be true and he starts mentioning how you
have four payment options then this loan (called an
option arm or
pay option loan) is not
the common interest only loan you have heard
your friends talk about. The best way to understand all the
interest only programs is by using our
products
tab on the top menu.
Possible Payment Shock ...
In order to
understand the possibility of payment shock you must first understand
what an interest-only loan is -
see above.
Many of today's home loan programs offer interest-only payments for only
a defined period of the note so something has to happen in order for
your loan to be repaid within the original terms of the note. For
a basic summary let's assume you have a 30 year note with 10 years of
interest only payments. Your lender still requires the note to be
paid off in 30 years. What happens here is that after your
interest only period has lapsed you will begin to pay "principal and
interest" payments to the lender. The possibility of payment shock
is very real for those consumers who hold on to these loans past the
interest only period. The reason is simple. Since you are
required to pay off this loan in 30 years you now have only 20 years
remaining (using the example above). In order for a lender to
amortize your loan and ensure repayment in the remaining time period
your loan payments will now be calculated on a 20 year schedule using
your current balance. Remember, the payment shock is very real for
those consumers who have paid nothing towards principal in the first ten
years. The more principal you pay down during your interest-only
period the less shock your new payments will be but it doesn't mean
payment shock will not exist since many factors go into determining your
payments when the time comes including then current interest rates.
Are these long term loans -
Who are they for?
Unless your risk level is high then interest-only loans are generally
not long term loan programs. However, with the said,
interest only loans can provide a great option for many homebuyers such
as:
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High Net Worth Individuals:
Consumers who generally do not wish to tie up the equity in
their home and would prefer to invest the extra money into markets
of better return.
-
Young Professionals:
Consumers
who are sure their income will grow but would like greater
purchasing power today. For example, young lawyers & doctors
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Short Term Homeowners:
Consumers who know the time frame for home ownership is within a
certain window of time and are more concerned with payments than
equity.
-
Real Estate Investors:
Consumers purchasing investment property find interest only loans
very valuable in areas where real estate appreciation is high.
This is not to say that an interest-only loan may not be right
for you but every program has a certain profile of consumers who tend to show the majority of interest. If you think
an interest-only loan can benefit your life it would be a good
idea to contact a mortgage lender & consult with your financial
advisor to make the best decision for you and your family.
After the interest-only period how will I know my rate?
This is a very common question
from consumers who are new to the interest-only mortgage product.
After the interest-only period your loan will be
subject to future market rates however your margin will not change throughout
the remaining term of the loan. Your interest rate will adjust
regularly according to the predefined terms contained within your
interest-only mortgage note. It's usually on an annual basis but
varies from lender to lender. It is important that you ask you
loan officer before you apply. Below is a hypothetical example of
what could happen when a consumer comes out of the interest only period. Let's say your note
called for your interest rate to be determined by adding the current
libor rate + a margin of 2.25. If the libor rate is 2.00% during
month 61 you will have a new interest rate of 4.25% until the next
adjustment period. It's important to remember that these are now
principal and interest payments so your payment may be higher even if
your interest rate is lower.
How can you measure your risk level?
It is extremely important to note that your risk level is not always
judged by how you feel. Many factors go in to determining if an
interest only loan is right for you. It is imperative that you
understand the following points before searching for a loan officer:
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A Loan Officer Should Not
Be Your Only Advisor -
Many mortgage professionals are only trained in
one area of the financial sector and can not advise you If an
interest-only loan is the best financing program for you and your
family. He/she can answer your questions on interest only loan
programs and help guide you towards making a better informed decision.
-
Loan Officers are not Financial
Advisors - They are sales people.
If you are seeking financial advice you need to seek the assistance
of a trained professional such as a CPA, retirement planner or
investment advisor.
It is a fact that if you are on a fixed income and are
pretty sure that your income may not rise in the future then interest
only loans will probably bear a much greater risk for you. As with
all matters that have to with your finances you should consult a
financial advisor who is aware of your unique situation before entering
into any agreement with a mortgage lender. Never rely on the sole
words of a loan officer.
My Income is limited - is an Interest-Only Loan for me?
if you are on a fixed
income then interest only loans will bear a much greater risk for you.
It is highly recommended by most real estate professionals that
consumers with limited income do not engage into home loan
programs with interest only payments. Once the interest only
payments are over you may find yourself in financial trouble due to
higher monthly payments. Additionally, if your credit has changed
you may be forced into a position where refinancing is not a very
attractive option. Although we do not provide advice as a rule we
can say that it's important - probably imperative - that
consumers with limited income plan on the future, not the short term.
This is what interest only programs are - short term options for a
select group of homeowners.
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