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THE SMART
NEG AM
Here we will see why a loan with the
potential for "negative amortization" may make the most sense
for you, even if you currently have a low fixed rate. First of
all you need to remember that most neg ams only go negative if
you let them (you normally have four monthly payment options),
and the maximum your loan balance can ever go up is usually only
110% to 125%. It's what you do with the deferred interest
savings when you choose the lowest payment option that makes the
difference. Let's take a hard look at a neg am loan.
1. How does a Neg Am or Flex Pay loan
work?
The main factors that make up all
adjustable rate mortgages are; the start rate, the
index, the margin, and the life cap and/or
payment cap. The difference between a conventional
adjustable and a neg am, is the neg am has a payment cap
for each adjustment period, whereas a conventional adjustable
has an interest rate cap each adjustment period.
Sometimes the minimum payment on a neg am is not enough to fully
amortize the loan. When this happens it's called negative
amortization or deferred interest. The start rate is what your
starting payment is based on, your payment is usually fixed for
a year and can not increase more than 7.5% per year, for
instance if your payment was $1000.00 a month, the most it could
go up would be 7.5% or $75.00. Then you have the index and
margin, the margin never changes, the index can fluctuate. The
two added together total your effective rate. Most neg
ams give you four payment options. A payment that fully
amortizes the loan in 15 years, a payment that fully amortizes
the loan in 30 years, an interest only payment, and a payment
that adds deferred interest back to the principal. The amount
of deferred interest or negative amortization is the difference
between the interest only payment and the minimum payment.
2. Aren't adjustable rate loans riskier
than fixed rate loans when the rates go up?
Not always, it depends on what rate
goes up. The interest rate on adjustable rate mortgages depends
on what the index it's tied to does. There are two types of
indices: cost driven, and market driven. Some
examples of market driven indices are T-Bills, CD's, Libor, and
Prime. Some examples of cost driven indices are The 11th
District cost of funds or COFI as it is commonly called, and the
Cost of savings index or COSI for short. Historically market
driven indices have been more volatile, for example the Japanese
own almost as many T-Bills as the USA, just think what would
happen to that index if they were to ever sell? On the other
hand the cost driven indices have built in mechanisms to keep
them low. The Cost of funds index, or COFI , is the weighted
average of interest rates that Federal Home Loan banks have paid
to their customers recently. Usually, the COFI for the 11th
district of Federal Home Loan Banks is used and covers banks in
California, Nevada, and Arizona; of course they want to keep
that rate down as low as possible. The COSI index is the
monthly weighted annualized rate paid out on all deposits taken
in by Golden West Financial, a 40 billion dollar company, of
course they want to keep that rate down as low as possible as
well. You can click here to see the history of these indices.
|COFI index|
|COSI index|
3. Why would I want a loan
where the balance can go up?
It depends on what you do with the
savings from the deferred interest. If you go to Vegas and blow
it, then it may not make financial sense for you; but if you
apply the difference you would be paying on a conventional loan
to high interest credit cards, or put it into a savings vehicle
such as a 401k (especially if it's matched by your
employer) or mutual funds etc, you'll be amazed at how much
smarter a flex pay loan is compared to a fixed rate or a
conventional adjustable. If you combine this with an
automatically deducted free of charge bi-weekly payment you'll
be able to reach your financial goals probably in half the time
you thought. Let one of our professional loan consultants
do a no obligation loan analysis right over the phone.
4. How will I ever pay off
my loan if deferred interest is making the balance go up?
Your neg am adjustable is
designed to pay off on time. It's guaranteed. While there are
occasions when deferred interest can add to your loan balance,
there are many other periods when your loan pays off faster than
the normal rate. Over time these periods of deferred interest
and faster payoff offset each other. The result: your mortgage
pays off on schedule.
5. Must I have deferred
interest on my loan?
No. Your loan has a deferred
interest payment option that offers you four different payment
choices that are clearly marked on your monthly payment coupon.
These choices are fifteen year fully amortized, thirty year
fully amortized, interest only, and a deferred interest option.
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