Interest only option and negative amortization mortgages are becoming extremely popular in the mortgage industry as House prices soar and payments soar in the same direction. These types of mortgages can offer substantially lower payments to a home buyer and extend that buyer's borrowing power.
The interest only option allows the appreciation of the home to build equity instead of making payments to reduce the principal. For instance, after making payments in a $300,000 home for 5 years one may have a balance of $280,000. If the house appreciated to $320,000 one would now have $40,000 in equity. An interest only option in the same scenario would have a balance of $300,000 and $20,000 in equity. The difference is that the payment on the fixed rate mortgage would be much higher than that of an interest only as part of the payment is paying principal. With the interest only, one would have paid roughly $7,000 less in payments and would have a much lower payment.
In this scenario the buyer is utilizing the appreciation of the house instead of their own money to earn equity. This is a good option in a very strong housing market where the home values are increasing very dramatically and very quickly.
A negative amortization mortgage is generally done where a buyer has a large amount of equity in their home and they are willing to allow the mortgage balance to increase in order to substantially lower their payment. A Negative amortization loan is similar to an interest only option in that the person is only paying interest on the loan. The difference is that one is not paying enough interest to cover the actual interest cost of the mortgage. The interest that they are not paying is being added to the mortgage balance. The person will ultimately owe more on the home than the balance when they initially began.
The positive aspect is that the payment is substantially lower than even an interest only mortgage. The negative is that you are actually increasing the balance of ones mortgage. This type of financing would be used for a person who is planning on selling their home in the next few years and would like a substantially lower payment in the mean time. This is only available for a person with a large amount of equity in their home. It is beneficial to a person who is going to retire in two or three years.
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