A friend of mine called me to let me know that he had received some good news in the mail. He received a letter from a lender in California informing him that they would give him a mortgage for $ 310,000 and that his monthly payment would only be $ 999! “Think about the house I could buy,” he said enthusiastically! Wow! What am I waiting for? ”
I am a big fan of low rate fixed mortgages and I was very wary that the kind of mortgage he was talking about was not. So I told him to bring me his letter and we could figure out exactly what he was entitled to. Instead, he invited me to his home. I thought it was a good idea because he has a pool table and it might be a consolation for him because as I put his dream of living in a mansion on hold he would annihilate me at 8-ball .
A negative amortization mortgage
I came to his home prepared. I found out that a 30 year mortgage of $ 310,000 with a monthly payment of $ 999 is a 1% interest mortgage. Then, when I read the proposal he had received, it was as I expected. This letter offered a negative amortization mortgage.
I must have read very small print, but after doing it, here’s what I found out. Once you close on the $ 310,000 mortgage, you have up to three years during which they will accept a minimum monthly payment of just $ 999. During those three years, no matter what you pay, the mortgage is a 7% mortgage.
To amortize normally or be repaid normally, a mortgage of $ 310,000 at 7% for 30 years requires a monthly payment of $ 2,062.44. This amount of $ 2,062.44 includes interest and principal. At the start of a negative amortizing mortgage, no principal is paid. The entire payment is used to pay the interest on the loan.
The interest owed on the first installment of this loan is $ 1,808.33. As the payout will be $ 999, $ 809.33 ($ 1,808.33 – $ 999) will be added to the principal. Since this mortgage will have an increasing principal rather than decreasing, it is called a negative amortization mortgage.
Now you pay!
With the terms of this mortgage, he would accumulate $ 32,316.76 in additional debt over 3 years, which, added to the original mortgage of $ 310,000, adds up to $ 342,316.76 in principal owed. When the negative mortgage amortization period ends, the mortgage becomes a regular mortgage. In this case, it happens after 3 years. Then there are 27 years left to pay the $ 342,316.76 owed at 7%. This would take a monthly payment of $ 2,354.51. Far from $ 999 per month!
There are many variations of negative amortization mortgages, but this example gives you an idea of how they work. Lately, it seems that the most popular type of negative amortizing mortgage is using a 40-year term. Sometimes small payments are allowed for up to 5 years and the principal is allowed to increase up to 25% more than its original value.
The idea behind negative amortization mortgages is simply to get more people to qualify for a large mortgage, even though at the end of the negative mortgage amortization period they may not be. not be able to make the much higher payments.
Of course, in a perfect market, the value of the property will increase more than the amount that the negative amortizing mortgage will add to the principal owed. So, in this perfect market, one would gain equity in the property. Then he could sell the property for a profit.
Watch out! Negative Amortization can blow up in your face!
If a negative amortizing mortgage had not been available, he would not have been able to qualify for a loan large enough to purchase the property and therefore could not have made a profit. However, this is what I call dynamite speculation. Dynamite speculation is speculation that can explode in your face.
I would never recommend taking the risk that a negative amortizing mortgage presents to a borrower. He might not be able to meet the large monthly obligation that he will eventually have, and if the price of his property did not skyrocket he would not be able to sell his property for a profit. He would therefore risk foreclosure.
While I was in the process of being creamed for the seventh game of 8 balls in a row, my friend realized that a negative amortizing mortgage was not good for him, and maybe not for nobody. He further realized that a few hours ago he was all set to buy a new home when he had not previously considered doing so. This is where the power of an advertisement for a negative amortizing mortgage lies.
In the classic “Smokey and the Bandit” movie, Sheriff Buford T. Justice walks up to a young man who was about to remove parts from an abandoned vehicle. He told the young thug to turn around and put his hands on the car.
Then the lawyer gave the young man a good boot in his pants and warned him: “It was a source of attention!” When you see an ad for a mortgage that offers a large loan with a very small monthly payment required, that also attracts attention. So beware, if you have a mortgage other than a fixed rate mortgage after you catch your eye, that could change and, like Sheriff Justice, gives you a really good kick.
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