Deferred Interest Mortgage

You pay interest on your mortgage....later. Like it just accumulates. And then one day, you pay big. (See: Zero Coupon Bond.)

One of the more surprising customs in the financial world is the fact that there is a pre-payment or early redemption penalty on paying off debt early. You actually get charged extra for paying off a debt before it's due. One would think that most lenders would prefer getting their money back faster, but certain loans are structured for their monthly income streams, and the penalty is a disincentive to stray from the model.

Luckily, the mortgage industry is fairly flexible and innovative in accommodating a range of variable payment structures. Any type of mortgage designed to have either a portion or entirety of the standard interest to be paid later than on a monthly basis is said to be a "deferred interest mortgage." This term includes Adjustable Rate Mortgages and mortgages that deploy balloon payments. Adjustable rate mortgages may entail paying less interest for some months and more other months. Balloon payments often are calculated for a certain rate, but the payments are done in a single, consolidated large lump sum rather than incrementally on a regular calendar schedule.

So the next time you win that lottery, make sure you convert your mortgage to a deferred interest mortgage before making the balloon payment to close it out, or you can get hit with the pre-payment penalty.