How do interest deferred mortgages work?
by Mortgage Rates on Friday, October 29th, 2010 | 4 Comments
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Check out the sight I listed it was very helpful to me when I considered the same option. Needless to say I choose not to do it.
Good Luck
Interest deferred would mean that any payment made by the borrower goes only towards the principal. The interest accrues and is repaid in a lump sum either at a period specified btw the bank & borrower or at sale. This is typically done for short term deals since banks make their money from charging interest. They are very rare and I have only seen them loans that would otherwise go into foreclosure.
Basically the interest has to be paid eventually and then you have essentially just increased the principal to be paid in a lump sum or via refi later on.
Often called a Option Arm loan they have upsides and down sides.
You get a loan with a start rate around 1-2%
Lets use 1.25% for an example. This isn’t your ARP it’s just a rate used to calculate your starting minimum payment.
On $200,000 with a start rate of 1.25% your minimum payment would be
Min Mon Pmt
1st Year$666.50
2nd Year$716.49
3rd Year$770.22
4th Year$827.99
5th Year$890.09
Other Payment Options
Interest Only$1,213.67
30 Year$1,368.70
15 Year$1,829.34
Each month you can select whatever payment you want from the minimum payment to the whole loan amount. These are usually 5 year loans.
The catch.
The interest rate is variable. It’s tied to an index. Usually MTA or COFI. If you have a choice pick MTA. It doesn’t move as fast up or down so if the economy changes you interest doesn’t jump as fast. The other figure that determines your interest rate is the margin. This is the amount added to the current index figure each month to come up with the rate you will be charged for your mortgage. The MTA has been around 4 – 4.5 all year. With a margin of 2.5 – 3 on average that would put your actual interest rate around 7%.
So your mortgage balance actually goes up every month. But so does the value of your house. Depending on what loan to value you started at this can be an ok thing.
The benefits
You can pick the lower payment use the money to invest in something or pay off other debt with higher interest and come out ahead.
In 3 years when the minimum payment starts getting higher you can always refi back down to the 1.25% start rate again. At this time you will pay off all the defered interest and that year you will take a huge tax break.
If you do invest the extra money for retirement or college savings for your kids you can still right off the defered interest. And build a nest egg for later.