The mortgage loan marketplace has evolved a long way from its original offering of the 30 year fixed interest rate mortgage, or a basic adjustable interest rate mortgage loan (ARM). The mortgage market today seems to have as many different mortgages offerings as the people that are applying for them. One recent newcomer to the mortgage scene is the so called “Option Mortgage Loan.”
Option mortgages give the homeowner the “option” of paying interest due on a given month. The risk that comes with this type of loan is that your mortgage balance will grow instead of shrink over the years. This is a relatively new phenomenon called “negative amortization.” Negative amortization happens when a homeowner who is making the minimum payments doesn’t paying enough to cover the interest due for that month. This homeowner will actually end up owing more over the years than they did when first financing their home. Here is a summary of how negative amortization occurs for a homeowner with an option adjustable rate mortgage:
Option adjustable rate mortgages in the beginning offer a special interest rate, sometimes as low as 1 to 1.5 percent. (For the first 30 days that is) The homeowners payment stays at the low amount for an entire year due to this special introductory offer. After the first month, the interest rate changes based on the current adjustable interest rate and lender margin. This rate may even change every month due to fluctuations in the markets. Meanwhile, the unsuspecting homeowner is still making the minimum payments while the outstanding interest is being tacked onto the principal balance. This phenomenon is called “Negative Amortization” and can compound with additional interest charged on the mortgage principal balance.
The danger with this type of loan is once you are under water it can be extremely difficult to get out again, especially if you have a limited income. If you financed your home with an Option ARM, the best thing you could do for yourself is refinance to a fixed interest rate mortgage now and save yourself from a right kafuffle.