NEGATIVE AMORTIZING LOANS

Some types of ARM loans (for example, option ARM loans) offer payment caps rather than interest rate caps, which limit the amount the monthly payment can increase. If a loan has payment cap, but has no periodic interest rate cap, then the loan may become negatively amortized. For example: if the interest rates rise to the point that where the monthly mortgage payment does not cover the interest due, any unpaid interest will get added to the loan balance, so the loan balance increases. However, you always have the option to pay the minimum monthly payment, or the fully amortized amount due.

The advantage of negative amortizing loans is that you can control cash flow (relatively stable payment), take advantage of low interest rates relative to the market at any given time, and pay back the money borrowed today at a depreciated value years from now (because of natural inflation). This makes such loans a great tool for homeowners as long as you understand the mechanics of the loan procedures.

With most ARM loans, the interest rate can adjust every month, every three or six months, once a year, every three years, or every five years. The interest rate on negative amortized loans can adjust monthly. A loan with an adjustment period of 6 months is called a 6-month ARM, with an adjustment period of 1 year, the loan is called a 1-year ARM, and so on.

Most ARMs offer an initial lower interest rate than the fully indexed rate (index plus margin) during the initial period of the loan, which could be one month or a year or more. It is also known as “teaser rate”.

All ARMs are available with 30-year terms and some with 15 or 40 year terms.

Adjustable rate mortgages generally have a lower initial interest rate than fixed rate loans.