Flexible Asset-Backed Mortgage (FABM) Quiz

Flexible Asset-Backed Mortgage (FABM)

The Flexible Asset-Backed Mortgage (FABM), also known as the Interest Only Loan or the Negative Amortization Loan, is a type of mortgage that allows homeowners to pay only the interest portion of their monthly payments during a specific period. The loan balances increase over time because the principal is not paid off with each payment, but rather remains constant until the end of the term. This mortgage product was popularized by the Federal Housing Administration during the housing boom in the early 2000s, which led to widespread adoption and made it easier for people to buy homes.

Here are some key points regarding the FABM:

• It is considered a nontraditional mortgage product.
• FABMs were initially designed for high net worth individuals who could afford to carry large unpaid balances without worrying about future cash flow demands.
• During the financial crisis of 2007–2008, this type of financing became unsustainable for many borrowers when interest rates rose significantly, leading to a surge in foreclosures among those with these mortgages.
• In recent years, there has been a resurgence of interest in FABMs due to low interest rates, rising house prices, and the return of adjustable rate loans.

Understanding FABMs

FABMs typically feature five types of payment options:

1. Principal and Interest: Paying both the principal amount and the interest amount in full every month.
2. Interest-Only Payment: Paying only the interest amount every month, with no reduction to the outstanding balance.
3. Negative Amortization: Making less than the required monthly payment, resulting in an increased balance due.
4. Partial Principal and Interest: A hybrid option where the homeowner pays a set amount toward the loan's principal each month, creating a smaller balance.
5. Full-Term Balloon Payment: Not making any payments throughout the life of the loan and paying the entire remaining balance in one lump sum at the end of the term.

To understand how these payments work, consider a $150,000 loan with a 6% annual percentage rate (APR) having a term of 30 years:

• With a monthly principal and interest payment, the borrower would repay approximately $863 per month.
• If the borrower chooses the interest-only approach, they would only need to make a $286 monthly payment.
• However, the negative amortization option may require a monthly payment of just $396.

The primary advantage of FABMs lies in their flexibility to cater to varying income levels, providing an adjustable rate mortgage experience similar to traditional ARMs while maintaining lower monthly mortgage expenses.

Risks Associated with FABMs

Despite the potential benefits, there are inherent risks associated with FABMs. One primary risk involves the uncertainty of future income and potential changes in personal circumstances, such as job loss, unexpected medical bills, or divorce, which could lead to difficulty meeting the loan's escalating payment requirements. Additionally, adjustments in interest rates can affect the borrower's ability to maintain payments; if rates rise, the burden of higher payments may become overwhelming.