Alternative Mortgage Instrument (AMI)

What Is an Alternative Mortgage Instrument (AMI)?

An alternative mortgage instrument (AMI) is any residential mortgage loan that deviates from standard mortgage practices. For instance, it may be a mortgage that is not fixed-rate, fully amortizing, has monthly or periodic payments, or a standard term of repayment. Sometimes, an AMI is a loan with real property as collateral, with the money being used for some other purpose than purchasing the property.

Understanding Alternative Mortgage Instruments (AMIs)

​​​​​​​The term “alternative mortgage instrument (AMI)” is used to describe loans that don’t meet the usual standards for conventional mortgages. Unlike Federal Housing Administration (FHA) or U.S. Department of Agriculture (USDA) loans, conventional loans are not part of any government-backed lending program. So AMI lending can include loans with variable interest rates as well as interest-only loans. Most AMIs are residential mortgage loans and are considered a type of nonconforming loan, which means that qualification eligibility, pricing, and features can vary by lender.

These nonconventional mortgages often make it easier for consumers to purchase real estate by reducing monthly payment amounts and increasing the price that borrowers can finance. They can provide more affordable housing for middle-class homebuyers. However, the benefit they provide may offset with the rising cost of the mortgage if the borrower’s incomes do not grow at the same pace as mortgage payments.

These non-fixed interest loans have a variable interest rate that fluctuates over time. The rate has a basis of an underlying benchmark interest rate or index that changes periodically. As the benchmark moves up or down, the scheduled payments of the loan also move. AMIs do not have amortization of the principal. With amortization, the calculation of the total principal and interest spreads into equal payments over the life of the loan.

AMI History

AMI loans first became popular in the early 1980s, when high interest rates put home purchases out of reach for many first-time homeowners. Banks and savings institutions introduced a variety of alternative mortgages designed to reduce the homebuyer’s mortgage payment. These alternatives also helped the buyer finance a larger, more expensive home. 

As interest rates declined from 2001 to 2005, home sales and home values rose to record levels. Financial institutions responded with even more alternative mortgage loans, such as loans with a choice of monthly payments as in the option arm, low down payment loans with up to 100 percent financing, loans with 40-year amortization schedules, as well as variable-rate mortgages, graduated-payment mortgages, and reverse-annuity mortgages. Some alternative mortgages originated for specific borrower situations. However, they are costly to originate and see little usage.

Examples of AMI Loans

The most common example of an AMI loan is an adjustable-rate mortgage (ARM). With an ARM, the homebuyer pays one low fixed rate for a set time period. That rate then adjusts according to its underlying benchmark rate. The rate can continue adjusting periodically over the life of the loan.

Say, for example, that you have a 10/1 ARM and that for the first 10 years of the loan, you pay an interest rate of 3.25% for the mortgage. Once the 10-year period ends, your mortgage rate adjusts based on the underlying benchmark rate. If the rate is below 3%, then your loan rate will drop. If the benchmark rate is 4.25% instead, then your mortgage rate increases. Changing interest rates on an ARM can move your monthly payment up or down accordingly.

Another type of AMI is an interest-only mortgage. These loans reduce the required monthly payment for a borrower by excluding the principal portion from a payment. For first-time homebuyers, an interest-only mortgage also allows them to defer large payments into future years when they expect their income to be higher.

Other types of alternative mortgages include hybrid ARMs, variable-rate mortgages, and option ARMs, to name only a few.

Pros and Cons of AMI Lending

AMIs could make home buying more accessible for certain borrowers, especially in a competitive housing market. Down payment requirements may be lower compared to a conventional mortgage loan, which could make it easier for someone with fewer liquid assets to buy. They could also appeal to someone who’s just starting out in their career and isn’t yet earning much. If they expect their salaries to increase over time, that could allow them to manage potentially higher payments associated with an ARM or an interest-only loan.

However, there are some drawbacks to choosing an AMI loan over a conventional or government-backed loan. Because AMIs tend to be nonconforming loans, lenders may set higher credit score or income requirements to qualify. Thus, getting approved isn’t a guarantee.

Beyond that, borrowers must consider the costs involved. While an ARM may come with a low initial rate, the mortgage could quickly become unaffordable once the rate adjusts. This assumes that mortgage rates move significantly higher compared to where they were when the borrower purchased the home. Refinancing can offer an “out,” so to speak, but it can take time and the borrower is responsible for paying appraisal and other closing costs.