Very often, consumers misunderstand negatively amortized loans.
A negatively amortized loan is not good or bad in itself. Most
negatively amortized loans are based on the 11th district Cost
of Funds Index (COFI), which represents the average cost of money
to the San Francisco Federal Reserve, the 11th of 12
districts in the U.S. The money for most 11th district loans comes
from deposits made by customers. The Savings & Loans institutions
making the majority of these loans tend to match the interest
rate on the loan to the interest rate they pay their customers.
Because the interest rate on S&L's depositor rates adjust
monthly, so do consumers’ interest rates. In addition, there are
no monthly or annual caps on the interest rate because there are
no caps on the checking, savings, CD & money market accounts
from whence the money comes. Even though there are no interest
rate caps, a quick look at the history of the COFI will show that
it normally changes less than 2% in a year. Because this loan
has no interest caps, the consumer protection agencies require
the loan to have payment caps, requiring that the minimum payment
not increase more than 7.5% annually. Say for example the minimum
payment in the first year was $1,000. It then follows that the
second year’s minimum payment cannot be more than $1,075. However,
since the minimum payment has caps and the interest rate has not,
the loan could become negative; if the interest rate increases
and the minimum payment does not increase sufficiently to cover
the interest payment, the loan balance would then increase. However,
the customer can always pay a fully amortizing payment based on
the current interest rate to keep the loan non-negative.
The main disadvantages of a negatively amortized loan is that
1) it is possible to lose equity in your property if you make
only the minimum payment and 2) following any upward jumps in
the interest rates, your rates would likewise increase. Not the
loan of choice if you want to build equity in your property and
do not plan to make more than the minimum payment.
However, this type of loan offers the advantages of low payments,
payment amount flexibility and quicker and easier qualifying.
Since these are loans made by S&Ls, they can also be a good
choice for first time homebuyers, allowing them to buy more than
they could otherwise afford. They are also well suited to the
self-employed borrower whose income may fluctuate month to month
and for rental properties since the payment flexibility can be
used to avoid negative cash flow.
In most cases, our Loan Specialists can advise you on the best
approach and help you with your specific loan requirements.
