Deferred Interest Mortgage

What Is a Deferred Interest Mortgage?

A deferred interest mortgage is a mortgage that allows the borrower to delay making interest payments on the loan for a specified period of time. This type of mortgage can mean lower payments in the short term but paying more in total over the life of the loan. It also has other risks.

Key Takeaways

  • A deferred interest mortgage allows borrowers to postpone paying some or all of a loan's interest for a specified time.
  • With a deferred interest mortgage, interest continues to accrue and will be added to the total loan balance.
  • Deferring interest can result in negative amortization, where the borrower's debt continues to grow even as they make payments.

How a Deferred Interest Mortgage Works

Lenders can tailor mortgage loans to allow for deferred interest payments by adding those terms to the contract. Deferred interest provisions can be complex for both the borrower and the lender since they require customization of the payment schedule. They can also be risky for the borrower, as we'll explain.

Types of Deferred Interest Mortgages

Deferred interest mortgages can be structured in a variety of ways, depending on what the lender and borrower agree to. These are the major types available today.

Deferred Interest Loans

Essentially, deferred interest mortgage loans allow borrowers to make payments that are less than the total payment they owe. Lenders can vary this provision in different ways, but they will usually require that the borrower make at least a minimum payment of a certain amount.

If a borrower chooses to make less than their full monthly payment, the reduced payment will go toward the loan's principal and some interest. The unpaid interest is then added to the balance of the loan. This increases the amount of interest the borrower will eventually have to pay. In addition, the unpaid interest will now start accruing interest, so that the borrower will have to pay interest on interest.

Deferring interest usually results in negative amortization, meaning that rather than decrease with each monthly payment, the borrower's debt continues to grow. For that reason, these loans are sometimes referred to as negative amortization mortgages.

Unlike most credit cards, which allow for debt to build up with no fixed end point, deferred interest loans have a definitive maturity date that will require the borrower to make a lump sum payment of any unpaid interest at that time. Some deferred interest mortgages provide options for obtaining an extension, such as through a loan modification or forbearance.

Note

Flexible payment adjustable rate mortgages, or option ARMS, which also allowed borrowers to defer interest payments, were effectively eliminated by the Consumer Financial Protection Bureau in 2014 because of the risks involved.

Graduated Payment Loans

Graduated payment mortgages are fixed-rate loans that start out with low monthly payments that rise by a certain amount each year. In theory, they are good for homeowners who expect to their incomes to grow fast enough to keep up with the rising payments and who could not afford to buy a home otherwise.

However, the interest and principal that is deferred to make those lower payments possible can also result in negative amortization.

Pros and Cons of Deferred Interest Mortgages

Deferred interest mortgages can help some homeowners, particularly first-timers, obtain homes with affordable mortgage payments, at least at the outset. That is their major "pro."

The list of "cons" however, is lengthier. For starters, the homeowner may not be able to afford the monthly payments when they eventually increase or to make a significant lump-sump payment at the end of the mortgage. That could mean defaulting on the loan and losing the home through foreclosure. Defaulting on a mortgage can also do serious damage to the borrower's credit score.

Because of negative amortization, the homeowner may ultimately owe more on their mortgage than their home is worth. If they wish to sell the home they may find that the money they could receive from the sale is less than they will need to repay their lender.

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  1. Consumer Financial Protection Bureau. "What Is Negative Amortization?"

  2. Consumer Financial Protection Bureau. "Ability-to-Repay and Qualified Mortgage Rule Assessment Report," Page 6-7.

  3. Consumer Financial Protection Bureau. "Ability to Repay and Qualified Mortgage Standards Under the Truth in Lending Act (Regulation Z)."