What is a Deferred-Interest Mortgage?
A Deferred-Interest Mortgage is a specialized type of home finance loan that allows the borrower to make lower payments by paying less than the full interest due on the loan’s outstanding balance. When you opt for this lower payment option, the unpaid interest is rolled into the loan principal, leading to a phenomenon known as negative amortization.
Understanding Negative Amortization
Negative amortization occurs in deferred-interest mortgages when the loan’s principal increases due to deferred interest payments. While this offers short-term flexibility, it can lead to a higher overall balance, complicating your financial situation in the long run.
Real-World Example
Consider the case of Jones, an entrepreneur with unpredictable income. To purchase his home, Jones opted for a deferred-interest mortgage. During months of low income, he made the minimum payments on his mortgage, thus avoiding late fees or penalties. The lower payments meant that he paid less than the interest due, causing his loan balance to increase. During months when his business income was higher, he made additional principal payments to mitigate the increase in the loan balance.
Pros and Cons of Deferred-Interest Mortgage
Pros:
- Payment Flexibility: Ideal for borrowers with variable income.
- Short-term Financial Relief: Lower monthly payments during financially strained periods.
Cons:
- Negative Amortization: Increases the loan principal over time.
- Complex Financial Management: Requires diligent planning to ensure the loan balance stays manageable.
Is It Right for You?
A deferred-interest mortgage can be a lifesaver for someone with fluctuating income, offering the necessary leeway to ride out financial lows. However, the deferred payments’ potential to increase the loan balance makes it critical to be fully aware of your long-term financial strategy.
Frequently Asked Questions
What happens if I only make the minimum payment on a deferred-interest mortgage?
If you only make the minimum payment, the remaining interest is added to your loan’s principal amount, leading to negative amortization.
How can negative amortization affect me?
Negative amortization increases your loan balance, making it more challenging to pay off your mortgage over time.
Can I switch from a deferred-interest mortgage to a different type of mortgage?
Yes, but it often requires refinancing, which can come with its own set of fees and conditions.
Is a deferred-interest mortgage suitable for people with a stable income?
Not typically. It’s more suited for individuals with variable incomes who might need flexible payment options. For those with stable incomes, other options like fixed-rate or interest-only mortgages may be more appropriate.
Related Terms: Negative Amortization, Adjustable-Rate Mortgage, Interest-Only Mortgage, Fixed-Rate Mortgage.
