You may consider a deferred interest mortgage if you want a lower payment at the start of a loan and a larger payment later on. Let’s learn more about the benefits and risks of these mortgage structures.
Definition and Examples of Deferred Interest Mortgages
Deferred interest mortgages are mortgages that offer lower interest payments at the beginning of a loan, with loan payments either increasing over time or due later in one lump sum. When these deferred interest amounts are due and how much interest payments increase depend on the loan’s terms.
Alternate names: Balloon payment mortgage, payment-option adjustable-rate mortgage, graduated-payment mortgage
Lenders offer a variety of payment schedules that can help borrowers qualify for lower payments on a mortgage, provided the borrower meets the criteria. For example, a balloon payment loan offers lower payments the first few years, then requires a large payment later in the loan or at the end of the loan term. This lump-sum payment makes up for the interest cost that you saved at the start. There are other types of deferred interest mortgages, as well, like the payment-option adjustable-rate mortgage (ARM). Interest on an ARM changes according to the interest of a benchmark index. Among this plan’s payment “options,” the borrower will usually find a deferred interest plan in which payments cover less interest than you owe. The remaining interest is added to your principal.
Example of Deferred Interest Mortgage
To illustrate, consider someone who wants to buy a $300,000 home. They have a tight monthly budget, but they believe they are on a good career track and will likely increase their income. A traditional 30-year loan with a fixed 3.42% interest rate on that home would require a monthly principal and interest payment of about $1,067. To reduce this payment, the buyer may consider a deferred interest loan that lowers their monthly principal and interest payment to, say, $800 for a certain period of time. Payments would then slowly increase over time to compensate for the total interest deferred. Or, in that same scenario, a balloon payment deferred interest loan might give the buyer $800 monthly payments with the stipulation that they’ll have a lump sum due later. For example, they may have to make a $10,000 or $20,000 balloon payment after 10 or 20 years of the loan. The actual amount and timing of a balloon payment will depend on the specific loan terms.
How Does a Deferred Interest Mortgage Work?
A deferred interest mortgage can be structured in a few different ways, but the general principle of delaying interest payments is the same. Any interest that isn’t paid earlier in the mortgage is added to the total principal of the loan and paid off through larger payments later. Deferring interest can result in a few months or even years of what is called negative amortization. This means that, for some amount of time, you could owe more on the house than it is worth on the market. Negative amortization is risky because, if you cannot make your payments or sell the home, you could face foreclosure. Negative amortization loans are more expensive in the long run. Borrowers should consider them carefully and weigh them against other options, like continuing to rent and save for a traditional fixed-rate mortgage.
Types of Deferred Interest Mortgages
One form of deferred interest mortgage is the balloon payment mortgage. This mortgage offers lower monthly payments with a larger payment due later. The risk of these loans is that your financial situation may not improve to support the payment of your balloon when it’s due. Other deferred payment options are the graduated-payment mortgage, a type of loan in which payments steadily increase. You’ll need to plan for how you’ll make these payments when they increase. A payment-option ARM is a loan product that lets you choose how your payment will be structured, such as:
A reduced-interest payment with the remaining interest due added to your principalAn interest-only paymentA traditional principal and interest payment
Are Deferred Interest Mortgages Worth It?
A deferred interest mortgage makes sense for some borrowers, depending on their financial situation. If you feel it is an ideal time for you to buy a home, and you have a tight budget but expect your income to increase, you might want to consider a deferred interest loan. However, these loans do carry risks, including the potential that you won’t be able to make higher payments later. Borrowers who can afford to pay full payments on a traditional mortgage can save more in the long run.
