What is a Pay-Option Loan?
Jul 25th, 2007 @ 3:49 PM by MortgageMentor
Everyday, I come across a new news article talking about the impacts of pay-option loans on home owners. These loans, also called negative amortization loans, provide home owners with a monthly payment option that is less than the amount of interest charged for borrowing the money each month. Because monthly payments are less than the total amount owed, the difference is added to the remaining loan balance.
For example: If you have a pay-option loan and your minimum payment is $750 per month, but the interest owed on the loan each month is $1,000; you are adding $250 in unpaid interest to your loan for each month you choose to make the $750 payment.
While pay-option loans can be useful in some borrowing situations, many home owners get in trouble with these loans by using them to buy homes that they wouldn’t be able to afford if they had to make more than the minimum payment. These home owners quickly add to the balance of their mortgage by making only the minimum payment.
These mortgages have provisions for the maximum amount you can add to your balance before the lender requires that the loan is repaid on a normal repayment schedule (full amortization). When this point is reached the loan “recasts” to a fully amortized loan which includes a full payment owed each month. This can put severe financial pressure on the home owner as the payment can be several times the minimum payment option.
If you have a pay-option loan and are making the minimum payment; be sure to talk to a trusted mortgage professional to determine when your loan is set to recast. I strongly suggest developing a financial game plan to account for the increase in your mortgage payment in addition to your other monthly expenses. Throughly research beforehand and calculate your mortgage payment possibilities beforehand.
MortgagePorter has taken an interesting look at prepayment penalties as has RainyCityGuide. By doing your homework, you can forego incurred costs in the long run.