Payment shock occurs when a monthly payment obligation increases substantially, usually as a result of a loan adjustment. Most commonly, payment shock occurs with adjustable-rate mortgage loans when the rate resets or when a payment switches from an interest-only payment to a fully amortized payment requiring repayment of both principle and interest. However, payment shock can also occur with any type of loan, including car loans or credit cards. You manually calculate the payment shock by subtracting the old monthly loan payment from the new monthly loan obligation.
1. Determine the old monthly payment obligation. For example, assume your monthly payment was $1,500.
2. Determine your new monthly payment obligation. For example, assume your new monthly payment obligation is $2,000. This increase commonly occurs as a result of a loan adjustment. For example, the loan could switch from an interest only to a fully amortized payment.
3. Subtract your old payment obligation from your new payment obligation. Continuing the same example, $2,000 - $1,500 = $500. This figure represents the payment shock associated with the loan.
4. Divide the payment shock amount by the new payment obligation. Continuing the same example, $500 / $2,000 = 25 percent. This figure represents the payment shock associated with the loan.
- Lenders often use the payment shock percentage for qualifying purposes during the loan underwriting process. Lenders that use this ratio typically set a maximum value for allowable payment shock. For example, a lender may set a maximum payment shock percentage of 20 percent. In this case, if the proposed payment shock exceeds 20 percent, the bank would typically not approve the loan.
- "Principles of Real Estate Finance"; Charles Long; 2010
- "Real Estate Principles"; Charles Floyd and Marcus Allen; 2002
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