Do 1.25% interest rates really exist? Neg am mortgages calculate several mortgagerates. One is called the payment rate the other is the actual interest rate. Fortunately, the payment rate is capped at 7.5% of the previous payment. The true interest rate is calculated as simply the index plus the margin without periodic caps. When the interest rate resets to a higher rate with a negative amortization Adjustable Rate Mortgage (ARM), the mortgage payment doesn’t change. Instead, the additional interest expense is added to the loan balance.

Homeowners are given a choice of which rate to pay, which is why negative amortization loans are also referred to as “payment option” loans and option ARMs. Cost of Funds Index (COFI), Cost of Savings Index (COSI), and Monthly Treasury Average (MTA or MAT) are all examples of Alt-A negative amortization loans. The Mortgage Bankers Association of America (MBA) says alt-A loans’ share rose from 8% to 11%. Why? Because of the flexibility these loans offer, not to mention affordability for a home purchase loan or if you want to cash out on your home equity with a mortgage refinance.

Another affordable loan option is the interest only loan. With an interest-only loan, you pay only the interest on the mortgage in monthly payments for a fixed term. After the end of that term, usually five to seven years, you must refinance, pay the balance in a lump sum, or start paying off the principal, which increases your monthly payments substantially. Like neg am loans, interest-only loans are option ARMs because borrowers have the option of paying only the interest or paying principal and interest.

Negative amortization and interest-only loans can be useful if you are primarily concerned with cash flow instead of building equity. If you only pay the payment rate, the overall monthly mortgage payment might be lower than a typical 30-year, amortization loan. If you’re a short-term borrower who plans to refinance or sell the home within a period of a few years or if you have unsteady sources of income or too little documented income to qualify for a traditional loan, you may want to consider a neg am loan or an interest only home loan.