What is a Dual Index Mortgage
A dual index mortgage is a type of mortgage where the interest rate paid on the outstanding balance is indexed to an interest rate benchmark plus a margin, and the actual total mortgage payments are linked to a benchmark of wages and salaries for workers in a given economy or region.
BREAKING DOWN Dual Index Mortgage
Dual index mortgages gets their name from the fact that these two sets of data, the interest rate benchmark and wages and salaries benchmarks, are used to calculate the interest rate and payment amounts.
The initial mortgage payment is set at a certain level and rises or falls according to the wage and salary index. So the interest rate is tied in a way to the interest rate index, but can still fluctuate widely, which is why these mortgages are sometimes compared to adjustable rate mortgages (ARMs). The possibility of fluctuations that can occur at unknown levels and degrees make this type of mortgage highly unpredictable.
The rate at which payments increase or decrease can differ substantially from the rate at which the actual interest rate on the mortgage rises or falls. When the payment is less than a calculated interest-only payment, based on the interest rate of the mortgage, negative amortization is created.
Dual Index Mortgage Downsides
Dual index mortgages do not exist in the United States, but are popular in Mexico and other Latin American countries which historically have suffered from high levels of inflation. This type of mortgage allows borrowers to purchase homes when there is a large level of inflationary risk.
However, dual index mortgages are similar in principal to payment-option adjustable-rate mortgages (ARMs), which are popular in high cost areas of the United States. Like dual index mortgages, payment option ARMs offer the borrower initial monthly payments with the potential for negative amortization.
Payment option ARMs can allow deferred interest to accumulate, meaning the total owed by the borrower can escalate, especially if they opt to only make the minimum payments allowed. This means the borrower can find themselves “underwater” on the loan, especially during the initial period after the loan payments begin. Depending on how the payments and interest rates change, it could be quite a while before the balance owed on the loan begins to decrease. For this reason, these loans probably would not be a good choice for homeowners who think they may be likely to want to try and sell the property within a few years.