Minimum Payment Option Basics
A minimum payment option loan offers the borrower an opportunity to make a small minimum monthly mortgage payment instead of the larger usual payment.
A typical 30 year fixed mortgage requires a borrower to pay both principal and interest. Slowly over the 30 year life of the loan the amount is paid off.
A minimum payment option loan works very differently.
This loan type allows a borrower to make a much smaller minimum payment each month, usually for the first 5 years of the loan.
The minimum payment option may be so low that the borrower can pay less than the interest owed each month.
The minimum payment amount is based on a minimum payment rate. This can be as low as 1%. This is not the same thing as the interest rate, which is usually much higher. The minimum payment rate is the rate at which a borrower can make payments. Any payment under the interest only level adds to their loan balance because of negative amortization. If an interest only mortgage payment is $1,000 per month and the minimum payment is $800 then if the borrower pays the minimum $800 level the $200 difference is added onto the loan amount.
Minimum Payments Fixed
One of the appeals of this type of loan is that is minimum payments are usually “fixed”. This means that the minimum payment is usually fixed for each of the first 5 years of the loan. In each year the minimum payment may increase slightly, but it will remain at the same level for an entire year until it increases again.
Payment size can increase by 7.5%. If the minimum payment is $2,000 in year 1 then in year 2 the minimum payment will be $2,150.
Lenders may have exceptions to the minimum payment option. If the original loan balance exceeds a certain amount, such as 115% of the original loan balance the loan may no longer allow the borrower to make a minimum payment.
Check with your lender on what they require and allow for this type of loan.