'Dual Index Mortgage' is explained in detail and with examples in the Banking edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Dual Index Mortgages are products of Latin American countries. They are especially popular in places like Mexico that have experienced significant inflation levels historically. These kinds of mortgages permit borrowers to buy houses even when a substantial amount of inflation risk exists. They are not and have never been offered in the United States, though they have been compared to ARM Adjustable Rate Mortgages.
Dual Index Mortgages do show some similarities to the American Adjustable Rate Mortgages. Such ARMs have always been in demand in places in the U.S. that are more expensive to buy houses. As with these types of loans, the dual index ones provide the borrower with lower early monthly payments that will cause negative amortization to occur. This means that the loan balances will rise for many months before they gradually begin to decline.
With Dual Index Mortgages, the rate that the lender earns is indexed. This means that the rate becomes adjusted at periodically set time intervals. The banks are able to adjust the rate on the loan according to the market rate changes.
The borrowers suffer from other aspects of the Dual Index Mortgages. On the positive side, the first payments are designed to be affordable for the borrowers to be able to make. The payments and the interest rates are not the same with these loans. This is where they are significantly different from American ARMs. The payment could be figured at 5% for example while the interest rate due to the lender is 25% or even higher. The substantial difference between these two rates becomes an add on to the loan balance in the form of negative amortization. This means that it may be a great number of years before the balance on this kind of loan starts to go down.
The actual payment amount is determined based on a salaries and wages index. This amount will change each month. The reason the Dual Index Mortgages are dual is because the payments adjust with the income index at the same time as the interest rate adjust to the interest rate index. The hope with these mortgages is that the payment made by the borrower will one day reach the level where it more than covers the interest rate so that the loan balance can decline finally.
The problem with this is that salaries and wages may not match inflation increases in Mexico and other Latin American countries. This would cause the borrower payments to not increase quickly enough for the loan principal to be paid down. In this case, there are remaining unpaid principal balances at the end of the loan terms. Some lenders in Mexico have been willing to underwrite Dual Index Mortgages where they take on this significant risk. The majority of them receive insurance from the government of Mexico. If there are unpaid remaining balances, the government will absorb the losses.
Besides these Dual Index Mortgages, Mexico has also experimented with some other kinds of home loans. One of these is known as the PLAM, or Price Level Adjusted Mortgage. These are less common than the dual index types.
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