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What is Deferred Interest?
Malcolm Tatum
Malcolm Tatum
Deferred interest is any interest that is applied to the balance on a loan, when the terms of the loan agreement makes it possible for the next payment due to be less than the amount of interest that is due. This type of arrangement is sometimes found in what is known as an adjustable rate mortgage, or ARM. It is also possible for a fixed rate mortgage to be structured with provisions that allow for deferred interest. When the deferred interest causes the balance of the loan to increase, this creates a situation known as negative amortization, since the balance did not decrease as a result of the payment.
One of the easiest ways to understand how deferred interest works is to consider an adjusted rate mortgage that includes this feature. If the interest payment option of the loan is $1000 US Dollars (USD) and the terms allow for a reduced payment of $800 USD, this creates a situation where making that reduced payment will result in adding $200 USD to the loan’s principal balance. There is usually no requirement that the debtor go with the lower payment and increase the balance as a result; he or she may choose to waive the offer of deferred interest and make the full payment. This is because exercising the deferred interest option on an ARM does increase the potential for the monthly payments to be increased at some future point in the life of the mortgage.
Fixed rate mortgages that include a deferred interest feature are often referred to as graduated payment mortgages. As with the adjustable rate mortgage, the graduated payment mortgage does allow the ability to periodically make a reduced monthly payment. While this arrangement can be helpful if funds are tight, it also increases the chances that the regular monthly payments will increase later on. For this reason, it is important to make use of deferred interest only after considering the possible future impact the decision will have on the monthly budget.
The use of deferred interest in mortgage contracts is not unusual. This type of interest provision can be found in both residential and commercial mortgages that are issued in many nations around the world. When employed to best advantage, the arrangement can make it possible to arrange the payment of debt obligations so that the impact to the loan itself is minimal, while also allowing the debtor to avoid late fees or other penalties associated with obligations other than the mortgage.
Malcolm Tatum
After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including WiseGEEK, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.
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Malcolm Tatum
After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including WiseGEEK, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.
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Discussion Comments
I know deferred interest is often used with adjustable rate mortgages, but the whole thing would make me a little nervous.
I would rather know up front how much I am going to be paying for the life of a loan. In some situations it can work out to be advantageous though.
I have some friends who had an ARM and because of the low interest rates, their payments actually went down. In another 5 years it will be adjusted again, and it could be much higher.
There are many income situations where a deferred interest loan works for people. I just know I am the type of person who would rather have exact amounts from the beginning to the end.
@starrynight - I don't think deferred interest is all bad. As the article said, if you get a flexible loan, you could make the full payment some months.
I know for people like myself and my boyfriend, our income varies a lot. I'm a freelancer, and he's an hourly employee without guaranteed hours. Sometimes we make a lot of money, sometimes not. We do try to save during the good times, but if we decided to buy a house it would be nice to make a smaller mortgage payment sometimes.
I think deferred interest on a mortgage is a really, really bad idea. Especially because they can raise your payment later. Also, as the article said, you're effective adding more money onto the balance of your loan.
I think part of the reason the recession happened is that people took on loans they really couldn't afford. They were lulled into complacency by deferred interest and variable mortgage rates.
If you look at the example given in the article, what if the people who had that loan could afford $800 a month but not $1000? They could end up in a bad situation if the bank raised their payment later on.
I really think people should only take on mortgages when they can afford the whole payment, without deferring the interest.
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