Loan Features To Avoid: Balloon Payments & Negative Amortization

[Rick Howell]

Among all the paperwork involved with taking out a mortgage, it is very easy to let your mind wander and simply sign on the dotted line. But be careful, you should read through the details of the loan.

You have to ask about, and also watch out for, these hazards to your financial health in particular. Although these are most commonly found in loans offered to borrowers with poor credit scores, these days they are being included in more loans marketed to borrowers with strong credit, particularly the newer ARMs (Adjustable Rate Mortgage) with ultra-low payments. You should be on the lookout for them in any type of mortgage.

Balloon Payments

Some ARMs are not scheduled to be paid off entirely by the end of the loan. They call for a final balloon payment which is usually a very large amount of unpaid principal. You are expected to refinance that balloon into a new loan, at whatever interest rate prevails at the time. When problems come with balloons, because the borrower’s situation has changed since taking out the loan. If a balloon comes due while you’re temporarily laid off then you’re in a tough situation. If you have a need for long-term financing like most homebuyers do then you should avoid balloons.

Negative Amortization

There is nothing positive to be said about negative amortization which is an increasingly common feature associated with ARMs. You’ll find it when interest rate is not capped but the payment is. Watch for the words “payment caps” in the advertising, that’s your clue that the interest rate is probably not capped. The interest rate may, indeed, rise faster than your capped payment. If that happens the unpaid interest is added to your principal balance. You end up borrowing more money instead of paying off the loan. Imagine borrowing against your credit card to make your mortgage payment each month. That insanity comes close to what you’re doing with a negative-amortization loan. Unless home prices continue to rise strongly – and you cannot bet on that continuing – you could end up having to write a check for tens of thousands when you sell the home, a prospect that could keep you trapped there when you’d prefer to move on.