Deferred interest is the amount of interest added to the principal balance of a loan when the contractual conditions of the loan make it possible to make a planned payment lower than the interest due. When the principal balance of a loan increases due to deferred interest, it is called negative amortization. For example, variable rate mortgages, called ARMs with a payment option, and fixed rate mortgages with a deferred interest feature, carry the risk that monthly payments will increase considerably at some point during the life of the loan. ‘mortgage.
Deferred interest breakdown
Deferred interest is interest accrued on a loan but not paid. Interest accrues when a loan payment is not large enough to cover all the interest owed.
History of deferred interests
Before the 2008 mortgage crisis, programs such as ARM payment options allowed borrowers to choose their monthly payment. Mortgagors could choose a 30 or 15 year payment, an interest payment only covering interest but not reducing the principal balance, or a minimum payment that would not even cover interest owed. The difference between the minimum payment and the interest owed was the deferred interest, or negative amortization, which was added to the loan balance.
For example, suppose a mortgagor received a payment option ARM of $ 100,000 at an interest rate of 6%. The borrower could choose from four monthly payment options: a fully amortized 30-year fixed payment of $ 599.55; a fully amortized payment over 15 years of $ 843.86; an interest payment of only $ 500; or a minimum payment of $ 321.64. Making the minimum payment means that deferred interest of $ 178.36 is added to the loan balance every month. After five years, the balance of the loan with deferred interest is recast, which means that the required payment increases enough to repay the loan in 25 years. The payment becomes so high that the mortgagor cannot repay the loan and ends up being seized. This is one of the reasons why deferred interest loans are prohibited in some states and considered to be predatory by the federal government.
With a deferred interest mortgage or an ARM with payment option, the mortgagor may have a payment limit and the interest rate may increase. Because the difference is added to the balance, rather than reducing the amount owed on a loan, the debt increases.
This can be a difficult situation, especially if the mortgagee wants to sell the house. A deferred interest can cause a borrower upside down in a mortgage, which means that he owes more than he can receive from the sale of the home.