You Or Your Client May Benefit From A Reduced Amortization Mortgage( RAM)
By Gerald Klugman
Most Real Estate Investors seeking financing for their properties want the longest amortization period that they can obtain. There are a number of reasons and benefits derived from a longer amortization period, even though they normally have a somewhat higher interest rate:
• The monthly payments on the mortgage are lower( despite the interest rate being higher), due to the mortgage extending over a longer period of time.
• The ratio of debt to equity remains higher over the term of the loan, meaning that the amount of leverage is greater.
• The initial ratio of interest to principal in payments on mortgages having longer amortization periods is higher, meaning a larger portion of monthly mortgage payments are tax deductible for Federal, State, and Local Income Taxes.
The first above listed item does not need explanation, but the last two attributes are less apparent. So, it is these which require further examination, as they are key characteristics and benefits of a Reduced Amortization Mortgage( RAM).
THE RELATIONSHIP BETWEEN THE INTEREST RATE AND AMORTIZATION PERIODS
On a typical amortizing mortgage, the amount of the monthly amortization increases by the monthly interest rate. So, the amortization amount on a mortgage that has a monthly interest rate of ½ % will increase over the previous month by ½ %. Stated in dollars, amortization of $ 10,000 included in the May mortgage payment will be $ 10,050 in the June mortgage payment. The period interest will decrease by the amount of the period increase in amortization. This all ties together, as the interest payment is computed from the remaining principal balance.
When the interest rate on a mortgage is low, the amortization is more constant from month to month than for a higher interest rate mortgage. The monthly amortization on a high interest rate mortgage starts out as less than the monthly amortization on a lower interest rate mortgage of a like mortgage amount; but increases at a more accelerated rate throughout the term of the loan. The following graph provides a visual of the effects of a range of amortization periods( 15 years, 20 years, 25 years, and 30 years) and a range of interest rates( 4 %, 6 %, 8 %, and 10 %).
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