Here we will see why a loan with the potential for "negative amortization" may make the most sense for you, even if you currently have a low fixed rate. First of all you need to remember that most neg ams only go negative if you let them (you normally have four monthly payment options), and the maximum your loan balance can ever go up is usually only 110% to 125%. It's what you do with the deferred interest savings when you choose the lowest payment option that makes the difference. Let's take a hard look at a neg am loan.

1. How does a Neg Am or Flex Pay loan work?

The main factors that make up all adjustable rate mortgages are; the start rate, the index, the margin, and the life cap and/or payment cap. The difference between a conventional adjustable and a neg am, is the neg am has a payment cap for each adjustment period, whereas a conventional adjustable has an interest rate cap each adjustment period. Sometimes the minimum payment on a neg am is not enough to fully amortize the loan. When this happens it's called negative amortization or deferred interest. The start rate is what your starting payment is based on, your payment is usually fixed for a year and can not increase more than 7.5% per year, for instance if your payment was $1000.00 a month, the most it could go up would be 7.5% or $75.00. Then you have the index and margin, the margin never changes, the index can fluctuate. The two added together total your effective rate. Most neg ams give you four payment options. A payment that fully amortizes the loan in 15 years, a payment that fully amortizes the loan in 30 years, an interest only payment, and a payment that adds deferred interest back to the principal. The amount of deferred interest or negative amortization is the difference between the interest only payment and the minimum payment.

2. Aren't adjustable rate loans riskier than fixed rate loans when the rates go up?

Not always, it depends on what rate goes up. The interest rate on adjustable rate mortgages depends on what the index it's tied to does. There are two types of indices: cost driven, and market driven. Some examples of market driven indices are CD's, Libor, and Prime Rate. Some examples of cost driven indices are The 11th District cost of funds or COFI as it is commonly called, the MTA or Monthly Treasury Average, and the Cost of Savings Index or COSI for short. Historically market driven indices have been more volatile, for example the Japanese own almost as many T-Bills as the USA, just think what would happen to that index if they were to ever sell? On the other hand the cost driven indices have built in mechanisms to keep them low.
The Cost of funds index, or COFI , is the weighted average of interest rates that Federal Home Loan banks have paid to their customers recently. Usually, the COFI for the 11th district of Federal Home Loan Banks is used and covers banks in California, Nevada, and Arizona; of course they want to keep that rate down as low as possible.
The Monthly Treasury Average or MTA is based on the average annual monthly yields of U.S. Treasury Securities, adjusted to a constant maturity of one year, as made available by the Federal Reserve. The index is determined by adding together the monthly yields for the most recent 12 months and dividing by 12. Because it's an average, higher yields in some months are offset by lower yields in others. It's considered one of the most sound choices for home investment, since interest rate increases take longer to affect the 12 month MTA than other ARM indices.
The COSI index is the monthly weighted annualized rate paid out on all deposits taken in by Golden West Financial, a 40 billion dollar company, of course they want to keep that rate down as low as possible as well. You can click here to see the history of these indices. |COFI index| |MTA index| |COSI index|

3. Why would I want a loan where the balance can go up?

It depends on what you do with the savings from the deferred interest. If you go to Vegas and blow it, then it may not make financial sense for you; but if you apply the difference you would be paying on a conventional loan to high interest credit cards, or put it into a savings vehicle such as a 401k (especially if it's matched by your employer) or mutual funds etc, you'll be amazed at how much smarter a flex pay loan is compared to a fixed rate or a conventional adjustable. If you combine this with an automatically deducted free of charge bi-weekly payment you'll be able to reach your financial goals probably in half the time you thought. Let one of our professional loan consultants do a no obligation loan analysis right over the phone.

4. How will I ever pay off my loan if deferred interest is making the balance go up?

Your neg am adjustable is designed to pay off on time. It's guaranteed. While there are occasions when deferred interest can add to your loan balance, there are many other periods when your loan pays off faster than the normal rate. Over time these periods of deferred interest and faster payoff offset each other. The result: your mortgage pays off on schedule.

5. Must I have deferred interest on my loan?

No. Your loan has a deferred interest payment option that offers you four different payment choices that are clearly marked on your monthly payment coupon. These choices are fifteen year fully amortized, thirty year fully amortized, interest only, and a deferred interest option.