Negative Amortization: Explained
Written by Yun Yang   

Negative Amortization, as opposed to positive amortization, occurs whenever the loan payment for any period is less than the interest charged over that period. The remaining amount of interest owed is added to the loan's principal, which ultimately causes the borrower to owe more money. All negative amortization home loans eventually require full repayment of principal and interest according to the original term of the mortgage and note signed by the borrower.

The amortization table below illustrates how an uncompleted payment results in interest added to the Principal (see the numbers highlighted red). In this example, the second monthly payment of a 20 years loan is less than the interest of the first period, resulting in more balance for the second period and more interest for the third period.

Initial Principle
Monthly Rate
Term
Monthly Payment		 $100,000
0.50%
20 Years
$600.00
 
No.
 Payment ($)
 Interest ($)
 Balance ($)
1 600 500.00 99,900.00
2 300 499.50 100,099.50
3 600 500.50 100,000.00
4 600 500.00 99,900.00
5 600 499.50 99,799.50
6 600 499.00 99,698.49
 

Reasons to Fall for Negative Amortization

The main reason negative amortization loans exist is to lower monthly payments. Some people use loans with negative amortization to get into a house they otherwise cannot afford. Usually they believe that they’ll have more income in the future. While you do enjoy lower payments today, the cost of a negative amortization loan is that you have to pay much more later.


Debt Caps

To hedge against the risk of unlimitedly accumulating principal, mortgage lenders always apply a debt cap on the loan.  Your mortgage contract may indicate that once the total debt exceeds 115 percent of the value of the home, the loan will automatically convert or may become due.  In both instances, you will certainly face a very huge problem.  First of all, you will be required to make regular payments that you cannot afford.  In worst scenarios, you will have to pay off the entire loan.  This means you need to come up with a huge sum of money in order not to lose your home.


A Word Of Caution

At first glance, negative amortization is very attractive.  But you have to understand that this repayment scheme is full of risk. If you accidentally fall too far behind, or let the principal creep up to past a certain level, the immediate demand for the whole sum of the loan could prompt a foreclosure. Before you take out a loan with negative amortization, you should study its impact on your finances.
 


 
Last Updated on Wednesday, 22 December 2010 05:40