What Is a Level Payment Mortgage?

A level payment mortgage is a type of mortgage that requires the same dollar payment each month or payment period. Level payment mortgages allow borrowers to know exactly how much they will have to pay on their mortgages each pay period. This stability makes it easier for them to create budgets and stick to them.

Level Payment Mortgage Explained

Level payment mortgages can be either fixed or variable-rate loans. This type of mortgage can sometimes result in negative amortization, which inflates the balance of the loan. These home loans are not appropriate for all types of homeowners and can result in financial entrapment for those who do not understand the possible consequences.

Ways Level Payment Mortgages Are Applied

With fully amortizing mortgages, level payments should cover bother a reduction of the principal amount as well as pay for interest on the debt. Initially, the majority of the payment will go towards paying interest on the loan with some deductions from the balance. Over time, how the payment is applied toward the mortgage will likely shift. More of the payment will go toward reducing the balance after the interest has been diminished.

The structure of level payment mortgages mixed with rising and variable rates of inflation have, from some perspectives, been cited as a contributing factor in past housing crises that even predate the financial turmoil of the early 2000s. In the earlier meltdowns of the market, increases in interest rates meant that more capital was needed to purchase homes. This meant that as buyers sought traditional, level payment mortgages, this financing may have been established against interest rates that were inflating the prices of homes beyond their actual market value. Furthermore, anticipation of further inflation and escalation of interest rates led to unnaturally rising annual payments.

That meant the buyer could be making payments that exceeded the returns they could realistically hope to see after the mortgages were fully paid off. Especially since the early payments would have largely addressed the interest, rather than the principal balance, the homebuyer would have effectively been losing money paying excessive interest before realizing any substantial equity in the home. By the time they actually began to pay off that principal balance, the value of the home could have dropped. That may have left them with an outstanding mortgage on a largely unpaid home that, even if sold, would not allow them to see any gain, let alone break even on the costs for the lifetime of the mortgage.