Have you seen the commercials on TV for mortgage loans where you can get a $150,000 loan for only $450 a month (rather than the usual $1000)? [Watch commercial]
The ad is for Quicken Loans’ “Secure Advantage” loan. Among the other claims being made are, “Choose a low payment month after month,” and “Cut your payment by over 50%.”
Who wouldn’t want to pay $450 a month for a loan that others charge $1000 a month for? That is some bargain, right? And the offer is coming from the namesake of the popular and respected financial software product, Quicken. How can you go wrong?
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Like the credit card companies, Quicken Loans is quoting only the minimum payment you can make on this loan each month. What is the downside of making only the minimum payment?
“When you choose to pay the minimum payment, you’re paying less than the full interest that is due for that month. By deferring your interest, the unpaid interest is added each month to your outstanding principal loan balance.
If you defer payment of interest, your outstanding loan amount could exceed the value of your home. This may affect your ability to refinance your loan or sell your home since you will owe more than what your home is worth. A higher loan amount may also result in larger payments down the road.” Â [Quicken Loans website]
In dollars and cents, the website’s example says that a $150,000 loan would only cost $438 a month because it uses an artificially low 3.5% interest rate during the first five years of the adjustable rate loan. If you only paid the minimum, by month 53 of the loan, your payment would jump to $934, then to $1078 after five years, and finally to $1389 after 10 years when you finally start to pay off some of the principal (the amount of which at this point is not stated, but higher than the original $150,000).
Negative amortization loans (where the loan principal increases rather than decreases) is a dangerous type of loan to enter into for the financially unsophisticated. It is shortsighted financial thinking to make financial decisions based only on affordable monthly payments, whether it be for a mortgage, car purchase, or credit card payment.
For more information about adjustable rate mortgages, here is a consumer handbook from the Federal Reserve Bank. [.pdf format]
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