Be Aware of the Negative in Negative Amortization LoansSheryl Landrum
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Home owners have learned how quickly their mortgage loan balances grew in negative amortization loans when they paid the optional payment rate of 1.5% versus the interest only payment on the fully indexed rate--which may be 5% or higher. There are also prepayment penalties involved with negative amortization loans.
Prepayment penalties put you in the penalty box with your home mortgage loan.Most optional payment or negative amortization loans are sold with hefty prepayment penalties, running from one to three years. These prepayments are "hard" prepays, meaning that you will pay the penalty regardless of whether you are selling your home or refinancing it. Buyers are told that a prepayment penalty reduces their fully indexed rate, which allows for less negative amortization. In fact, a one-year prepayment penalty is generally acceptable.
However, be careful before you commit to any prepayment penalty on your home loan as the penalty is generally six months of mortgage interest on your fully indexed rate. Remember, your fully indexed rate can be 5 or more percentage points over your start rate.
Other lenders will penalize you for having a negative amortization loan.If you think a prepayment penalty is fine because you are planning on staying in your home mortgage for awhile, there is another thing you should consider: Most lenders will not put a home equity loan or line of credit behind a negative amortization loan. Those few who will are only going to do so if your negative amortization loan allows for a maximum loan balance of 110% and you can qualify for your home equity loan or line if making the fully indexed payment on your negative amortization loan.
Keep out of the penalty box with your negative amortization loan.Whether it is in reducing your margin or your initial loan costs, prepayment penalties come into play with a negative amortization loan. To protect yourself:
- Negotiate the best optional payment mortgage you can.
- Also, have a contingency plan for emergencies that does not require refinancing your mortgage before the prepayment penalty is over.
About the Author
Sheryl Landrum is a Senior Loan Officer with First Capital Mortgage in San Diego and Prudential Realty in Bonsall, California.