1% Mortgage Loan
Have you seen the ads everywhere for "1% Mortgage Loans" - offers that show how you can chop you monthly payment in half?
These loans go by many names:
-payment option loans
-pick your payment loans
-option ARMs
-negam loans
This type of loan has become very popular recently, particularly in places with high and escalating real estate values where the loan can allow people to buy or keep expensive properties that may otherwise be out of their price range.
The 1% loan is a loan that has to be understood first because it can be good or bad, depending on your circumstances and goals.
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The 1% mortgage rate is usually an introductory rate (the APR or annual percentage rate is usually much higher, at 6.5% or more).
The 1% interest rate may only be for the first month.
The appeal of this type of loan is that it typically allows you to make a choice each month about how much you want to pay for your mortgage.
Payment Choices For 1% Loans
These choices each month are usually:
-a minimum payment (usually less than the interest-only level)
-an interest-only level
-a 15 year amortization level
-a 30 year amortization level
For example, a 1% minimum option loan on a $400,000 loan with a 30 year term can have four different initial payment levels:
-the minimum payment of $1,287
-an interest-only payment of $1,649
-a 30 year payment of $2,134
-a 15 year payment of $3,152
When you get your bill, you can decide that month how much you pay.
Quick Features Of 1% Loan
Here is the first catch: when you make the minimum payment, any amount short of the interest-only payment is added onto the principal of the loan. For example, if:
-the minimum payment is $1,200 per month
-interest only payment is $1,500 per month
-you are increasing the size of your loan by $300 if you only pay the $1,200 minimum payment ($1,500 less $1,200).
An increase in your loan size is known as "negative amortization".
If you continue to make minimum payments over time, your loan balance will continue to increase.
The level of your minimum payment can also be reset, typically on an annual basis. The minimum payment is usually fixed for 12 month periods at a time. Once a year, the minimum payment typically increases slightly.
For example, the minimum payment each month for the first year may be $1,200, then the second year it may be $1,300, the third year it may rise to $1,400, etc. This increase is usually predefined in the loan.
Minimum payment levels usually last for the first 5 years of a loan, after which the loan reverts back to a regular adjustable loan. You can't make minimum payments forever. Some loans come with a conversion option to change into a fixed rate loan at some period. Some people refinance around year 3 to get back to the lower minimum payment levels.
There can also be a reset to a regular loan if the loan size increases too much relative to the value of the property. This means that making minimum payments is no longer an option.
Interest Rate on 1% Option Loans
What is the interest rate on this type of loan? Usually it adjusts on a monthly basis and is the sum of an interest rate index plus the "margin" which is the bank's profits. The interest rate index can be based on different published indexes, such as the LIBOR, COSI, or CODI index. Some of these indexes change value faster than others. These loans also usually come with a lifetime cap on the interest rate, so the upside rate risk is clearly defined.
Is The 1% Loan Right For You?
If your loan continues to increase, and the value of your property drops, then you can end up owing more on the property than the house is worth. This loan is not for everyone.
If you have lots of equity in your property and don't mind you loan size going up, you may consider this loan. Often people have found that gains in property values are higher than the increase in their loan size. For example, a customer may start the year with a loan of $300,000 on a $400,000 property and may end the year with a $310,000 loan on a $450,000 property. The borrower's equity in the home has still increased, despite the increase in loan amount.
The 1% loan often only goes up to the first 80% of the value of the property, after which if an additional loan is necessary it is usually an equity line at a higher rate.
For rental properties, a minimum payment may allow you to collect enough rent to make a monthly profit or be closer to it. The minimum start rate is usually higher than 1%. It can often be 2% or higher on rental properties. It can still be helpful.
For some people a minimum payment may be the option they choose once in a while. Some months they pay more, some months they pay less.
For some borrowers the minimum payment may be an attractive option because it allows them to put the minimum cash into a property while riding up its value (this is the concept of leverage).
The risk of owing more on your property than it is worth is something to seriously consider.
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