Negative amortization

When the amount that you owe on a loan increases despite regular monthly payments

Negative amortization typically happens with an adjustable rate mortgage (ARM) that has a payment cap. This means that your monthly payment can only increase up to 7.5% from the last adjustment period.

Here’s how this type of loan works: the lender gives you three options on how to pay your monthly loan payment.

Typically, you can pay either:
(1) the full amount that's due, which covers both the principal and interest
(2) the amount based on the payment cap
(3) interest only

If you select the second method, you are at risk of negative amortization - if the loan's interest rate shoots up, you owe more money than what the payment cap accounts for. This unpaid interest is then tacked onto your loan. So, your loan balance creeps up instead of shrinking. Similarly, with the third method, the amount that's not paid on the principal is added to your loan.

This type of loan makes sense for people and companies who have seasonal or staggered incomes, or for people who want more flexibility and can manage their finances with daily updated spreadsheets.

See: Adjustable rate mortgage, Payment cap
Compare: Amortization

Lock-in rate

A lender’s guarantee for a specific interest rate on a loan

Until you request a rate lock, a loan’s interest rate quoted by either a lender or broker is probably going to change due to market fluctuations. The rules on how to do this will vary from lender to lender and broker to broker, but typically you can request a rate lock after you submit your signed loan application/1003 and other requested forms. Don’t let a low rate slip through your fingers. Once you have settled on a rate, the lender usually guarantees the rate for 15, 30, 45 or 60 days.

See: Lock period

Interest rate cap

The limit on how much the interest rate on an adjustable rate mortgage (ARM) can go up or down

Most ARMs have two types of interest rate caps:
(1) lifetime caps, which are required by law, that limit the increase and decrease of a rate over the full course of a loan. A 6% lifetime cap, for example, means the rate cannot go beyond 6 percentage points over or under the initial rate
(2) periodic caps, which limit the rate change from one adjustment period to the next, even if the market interest rates significantly rise or fall during this time. A lifetime cap is also referred to as aceiling or floor.

See: Cap

Initial interest rate

The starting interest rate of an adjustable rate mortgage (ARM)

The initial interest rate on an ARM, sometimes called a teaser rate, is fixed for a certain period then adjusts to reflect overall market rates. The lender starts you off with a very low initial rate, planning that interest rates will rise in the future and adjust to market rates.

Fixed rate loans, on the other hand always have the same interest rate for the life a loan, and the rate is usually higher than an ARM’s initial interest rate.