Question

With all other variables remaining equal, rank the payment amounts from lowest to highest for the following types of mortgages (interest only, fully amortized, partially amortized, negatively amortized)

Which of the loan types in last question has the most lender risk? Why?

Answer 1

Fully amortized mortgage

It is the most common type of mortgage wherein the principal and interest are paid in full through scheduled payments by the end of loan term. If the rate of interest is fixed, then every month an equal amount is paid till the end of the loan term. They are also called as self-amortizing loans.

Partially amortized mortgage

As the name suggests, in this type of mortgage a partial amount of installment is paid over the duration of the loan, and a balloon payment/lump sum is paid at the end. For eg, if in a fully amortized loan, a person pays an installment of 1000, in partially amortized loan he will pay 800 and the remaining 200 will accumulate every month and will be paid in the end.

Interest-only amortized mortgage

In this type of mortgage, only the interest is paid every month and the principal is paid after some time in a lump sum or in installments. It means as a borrower you will always owe the same amount of money regardless of how many payments you make.

Negatively amortized mortgage

It is a type of loan structure in which the borrower is allowed to make installments which are less than the interest charged on the loan. This creates a deferred interest and this amount is added to the principal and unlike in every other type of amortization wherein the principal decreases with time, in this scenario principal increases with every passing installment. As it cannot continue indefinitely, at some time the loan will start to amortize normally.

Most risky for lenders

Obviously negatively amortized is the riskiest type of mortgage followed by an interest-only mortgage. Lenders generally don't offer such type of loans anymore.

Partially amortized loans are used by people who face liquidity issues in the short term and hence prefer to pay a bigger portion at the end of the loan period. These are less risky as lenders are compensated by charging a higher interest rate from these types of mortgages.

Finally, the least risky one and the most common type of mortgage is the one which is fully amortized and an equal payment is paid every month till the end of the loan period.