What Types of Loans Can Get Me Upside Down On My Mortgage?
Typically, ARM’s and Interest-Only loans are the ones that have the greatest possibility of leaving the borrower upside down. To fully understand this danger, one must first comprehend what it means to be upside down on a mortgage. Very simply, the term describes a situation where the borrower actually owes more money in principal to the lender than the amount of the original loan. The process of becoming upside down is referred to as Negative Amortization. Every month when a borrower pays his mortgage payment, the outstanding balance of the loan does not decrease, but rather increases, meaning that he’s owing more and more every month.
Interest-Only Loans Allow You To Pay Only Towards the Interest and Not Towards the Principle.
How does this happen? Usually this situation arises when borrowers get Interest-Only loans, which allow for payment of only the interest every month, and then of course the payment minimum increases after a specified time to include both the interest and principal. By having a lower initial payment, borrowers have some time to adjust to owning a home for the first time, or to anticipate an increase in monthly income, or time to fix up the property to resell, etc.
Payments Rise Over Time
The downside here is that the payments will rise regardless of whether or not the borrower has successfully arranged for a higher monthly income, or listed the house for sale. Plus, if the borrower is forced to keep the property and the loan, then their new payments will actually be significantly higher than if they had purchased a traditional fixed mortgage from the beginning. This is because they have paid no principal, and often times their payment was not even enough to cover all of the interest due. Any unpaid interest every month will result in the balance being added to the principal, essentially increasing the overall outstanding balance. This way, borrowers will be paying interest on their mortgage interest.
Increased Payment Can Be Difficult for the Borrower
Lenders love this scenario because they’re double-dipping on the interest. Plus, the borrower now has 27 or 28 years to pay the balance of what would normally be spread out over 30 years, combined with the increased principal. This results in a staggering increase in the monthly payment minimum that many borrowers are unprepared to deal with. This threat is also present for those borrowers with ARM’s, although the risk of becoming upside down on the mortgage is less prevalent because the monthly payments during the initial “teaser” period actually contain legitimate principal and interest portions.
