Deferred Interest
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Deferred Interest is associated with payment option arm loans. It is interest that has accrued on the loan but is not required to be paid until later when the loan is paid off.Your loan will be "recast" when your loan reached a certain percentage of the original balance, or after a certain period of time. There are many different types of option ARM's, and the guidelines can vary significantly. When the loan is "recast" the lender is adjusting your payment to ensure the loan is paid off under the original loan term. For example if you take out a loan for $200,000 and your 30 year principal and interest payment (at 6.5%) is scheduled to be $1,265. If instead of making the 30 year payment you elect to make the minimum payment each of the first 5 years and defer the interest due, your may have a mortgage balance of $225,000. The lender at that time will calculate that you need to payoff $225,000 in 25 years. In order to do that you will need to make monthly payments of $1,520 per month, which will then become your new minimum payment.
Pay option ARMS are popular with investors. The deferred interest means a lower monthly payment and more cash flow to use for other investments. The deferred interest will be paid either when the investor sells the property or when the loan recasts due to the amount of accrued interest. For an investor to use a Negative Amortization loan properly he should have a firm plan in mind at the beginning of the purchase that accounts for the deferred interest.
It's important to take note that any difference between the interest accrued and the actual payment made is added to the loan balance. As always, speak with your mortgage professional to determine if this fits within your situation.
Most pay option arm loans will have a ceiling or a cap, to which you will be able to defer interest too. This is to protect you so that you do not become "upside down" on your home. Meaning, you will not owe more than is reasonable for you to be able to payoff. Remember your home is appreciating at all times, so the deferred interest will be able to be paid when you sell your home. If you do reach the cap, then the lender will make you begin to pay the principal down, again this is to protect you in the long run.