Deferred Interest Mortgage
What is 'Deferred Interest Mortgage'
A deferred interest mortgage is a mortgage that allows for deferral of some or all of the interest required on a loan.
BREAKING DOWN 'Deferred Interest Mortgage'
Deferred interest mortgage terms can be integrated to customize all types of mortgage loans. In the mortgage market, deferred interest is most commonly associated with balloon payment loans and payment option adjustable rate mortgage (ARM) loans.
Incremental Deferred Interest Provisions
Deferred interest provisions can be complex for both the borrower and the lender since they require customization to the payment schedule. Generally incremental deferred interest mortgage loans allow a borrower to make minimum payments that are less than the total payment owed. Lenders can vary this provision in different ways but will usually have a minimum payment that can be allowed for the borrower below the standard payment amount. If a borrower chooses to exercise their deferred interest rights and pay the lower balance, then the payment will cover principal and some interest. The excess interest is then added to the total balance of the loan. This increases the amount of interest charged on future payments.
Overall incremental deferred interest is usually synonymous with negative amortization. With incremental deferred interest, a homeowner lets interest accrue, ultimately increasing the totals cost of the loan. Different from deferred interest credit card debt, deferred interest loans have a definitive maturity and will require a borrower to make a lump sum payoff when the loan reaches maturity. There can be some considerations for deferred interest mortgages that will allow for an extension such as loan modification or forbearance.
Payment Option Adjustable Rate Mortgages
In the mortgage market, lenders can offer borrowers a payment option adjustable rate mortgage. This type of product is one of the most common loans where negative amortization will occur.
In an adjustable rate mortgage, borrowers pay both a fixed rate and a variable rate of interest. Payment options will likely start with a low fixed interest rate for a short period of time. Once the borrower reaches a specified reset date they will then have several options on the type of payment they would like to make in the variable rate portion of the loan. The borrower might make the minimum fixed interest payment. They may also have the option to pay only interest. They can also pay the standard variable rate that is required or they may also have other options determined by lender. In all scenarios except for the standard loan payment, the borrower will incur deferred interest since the payment is below the standard amount. The excess balance is then added to the outstanding balance.
In a payment option ARM, the borrower has various options at each payment time. They may choose to make the minimum payment in one month followed by a higher payment in the following month. Payment option ARMs were designed to help borrowers with volatile income levels since borrowers can choose from any payment option at each month when the payment is required.
Balloon Payment Loans
Balloon payment loans are a standard type of deferred interest mortgage. With a balloon payment loan the borrower makes no payments on principal or interest throughout the entire life of the loan. The borrower is required to pay off the loan in a lump sum that includes both principal and interest at the loan’s maturity date. Generally in balloon payment loans for longer than one year, lenders will structure the interest to accrue and defer annually. Lenders have the option to accrue interest on any schedule they specify in the loan terms.