Deferred interest is any interest that is applied to the balance on a loan, when the terms of the loan agreement makes it possible for the next payment due to be less than the amount of interest that is due. This type of arrangement is sometimes found in what is known as an adjustable rate mortgage, or ARM. It is also possible for a fixed rate mortgage to be structured with provisions that allow for deferred interest. When the deferred interest causes the balance of the loan to increase, this creates a situation known as negative amortization, since the balance did not decrease as a result of the payment.
One of the easiest ways to understand how deferred interest works is to consider an adjusted rate mortgage that includes this feature. If the interest payment option of the loan is $1000 US Dollars (USD) and the terms allow for a reduced payment of $800 USD, this creates a situation where making that reduced payment will result in adding $200 USD to the loan’s principal balance. There is usually no requirement that the debtor go with the lower payment and increase the balance as a result; he or she may choose to waive the offer of deferred interest and make the full payment. This is because exercising the deferred interest option on an ARM does increase the potential for the monthly payments to be increased at some future point in the life of the mortgage.
Fixed rate mortgages that include a deferred interest feature are often referred to as graduated payment mortgages. As with the adjustable rate mortgage, the graduated payment mortgage does allow the ability to periodically make a reduced monthly payment. While this arrangement can be helpful if funds are tight, it also increases the chances that the regular monthly payments will increase later on. For this reason, it is important to make use of deferred interest only after considering the possible future impact the decision will have on the monthly budget.
The use of deferred interest in mortgage contracts is not unusual. This type of interest provision can be found in both residential and commercial mortgages that are issued in many nations around the world. When employed to best advantage, the arrangement can make it possible to arrange the payment of debt obligations so that the impact to the loan itself is minimal, while also allowing the debtor to avoid late fees or other penalties associated with obligations other than the mortgage.