In most instances an Adjustable Rate Mortgage will be set with caps placed on the amount of interest charged each month or other set period. There are, however, some ARM’s which have a cap on the amount the monthly payment can be increased. With a payment cap rather than an interest cap, the loan has the possibility of becoming negatively amortized. What this means is that the interest rate increase may rise to the point that the monthly payment due is more than the interest applied to that month’s payment. When this happens, it becomes negatively amortized, then the additional amount due is added to the balance of the loan due. You will still have the option of paying the full amount if you so choose.
There are a few advantages to the negatively amortizing mortgage loan. It allows the homeowner to better regulate their cash flow by capping the amount they must pay each month. It also helps them to take advantage of a possible lower interest rate at some future time. Also, since currency naturally depreciates over time due to inflation, the extra money due can be paid back years later at this depreciated value. The negatively amortizing mortgage loan is something of a gamble and should not be attempted unless the borrower fully understands how the system works so they can monitor interest rates and pay larger amounts at the most optimal times.
Since many Adjustable Rate Mortgages begin with a short period of low interest (called “teaser” rates) the more one can invest in paying back the loan during this initial period the more they can save over the lifetime of the full loan.
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