A minimum payment loan allows a borrower to make a payment that is less than a regular payment and also less than an interest-only payment.
The minimum payment rate can vary based on different loans. This example is about a loan with a minimum payment rate of 1%.
It is important to note that the minimum payment rate is different than the interest rate. The interest rate on these loans is usually a combination of a margin and an index. The margin is the bank’s profit and the index is a third-party interest rate index, such as a LIBOR or CODI index.
Any time a minimum payment is made there can be negative amortization. Any mortgage payment amount short of the interest only payment is added onto the principal of the loan. In minimum payments are made the loan size actually increases. For many borrowers this doesn’t matter because their equity increases faster than their loan size, or they simply prefer having a much lower monthly mortgage payment.
Here is an example:
Current loan balance: 350,000
Loan Term in years: 30
Index value: 3.50%
Loan margin: 3.00%
Fully amortizing interest rate 6.50% (this is index+margin)
Annual minimum payment size increase 7.50%
Loan
Minimum payment rate 1.00%
Monthly Payments 1,126
Annual Payments 13,509
Monthly Payments Loan
Monthly payments year 1 1,126
Monthly payments year 2 1,210
Monthly payments year 3 1,301
Monthly payments year 4 1,399
Monthly payments year 5 1,503
Annual payments Loan
Annual payments year 1 13,509
Annual payments year 2 14,522
Annual payments year 3 15,611
Annual payments year 4 16,782
Annual payments year 5 18,041
Total payments years 1-5 78,465
The minimum payment size is the same for the first twelve months. Each year the monthly payment size increases by 7.5% in this example. This is not an increase in the interest rate. It is an increase in the monthly minimum payment size.
The minimum payment option usually only lasts for the first five years of a loan.
Minimum payment option loans can have 40 year terms, which offers an even lower minimum monthly payment than 30 year loan terms.
