Too good to be true
A client called me and asked, “I hear about these 1% loans, is it too good to be true?”
There are in fact loans with interest rate of 1%. But it is not what you think.
It’s a neg am loan, negative amortization. This means the monthly payment you make is based on 1% interest rate. But your note rate, or the actual rate is actually much higher.
The note rate is always an adjustable tied to an index plus a margin. For example, let’s say your adjustable rate is tied to the MTA index (12-Month Treasury Average) plus a margin of 2.5%. With the MTA at 2.8, plus 2.5 margin, your note rate is 5.3%.
The difference between the payment for 5.3% and 1% is put into the principle amount of your loan. Yes, your payment is low based on 1% interest rate, but your loan amount increases every month. If you took a loan out for $250,000 at the beginning of the year, your loan amount at the end of the year could be something like $265,000. And remember, the payment is based on your loan amount. As your loan amount gets larger, so does the amount that is added on to the loan.
That’s how the 1% loan works.