Negative Amortization Mortgage Loans: A Guide to the Basics and Beyond

Negative amortization mortgage loans can be a complex and confusing topic, but don't worry, we've got you covered.

These loans often have adjustable interest rates, which can lead to higher monthly payments over time. This can cause the loan balance to increase, rather than decrease, as you pay down the principal amount.

The key to understanding negative amortization loans is to recognize that they can have payment caps, which limit how much your monthly payment can increase. This can make it difficult to keep up with payments, especially if interest rates rise.

In some cases, negative amortization loans may have an introductory period with a very low interest rate, which can make the loan seem more affordable at first. However, once the introductory period ends, the interest rate may increase, leading to higher payments and potentially negative amortization.

A negative amortization mortgage loan is a type of loan where the borrower's scheduled payment is less than the interest charged on the loan. This results in deferred interest being created, which is then added to the principal balance of the loan.

The principal balance of the loan increases over time instead of decreases, making it a less-than-ideal situation for the borrower. This is because the borrower is not paying enough to cover the interest, causing the loan balance to grow.

In a negative amortization mortgage loan, the periodic payment does not cover the amount of interest due for that loan period. The unpaid accrued interest is then capitalized monthly into the outstanding principal balance.

The result of this is that the loan balance increases by the amount of the unpaid interest on a monthly basis. This can happen in loans where the purpose is for advanced cash management or payment flexibility, but not to increase overall affordability.

The recast period for a negative amortization mortgage loan is usually 60 months, and the recast principal balance cap is up to a 25% increase of the amortized loan balance over the original loan amount. This is based on federal and state legislation.

States and lenders can offer products with lesser recast periods and principal balance caps, but cannot issue loans that exceed their state and federal legislated requirements under penalty of law.

Negative amortization mortgage loans work in a way that's often misunderstood.

Most loans only allow NegAM to happen for no more than 5 years, after which the payment is recast to a fully amortizing schedule if the borrower allows the principal balance to rise to a pre-specified amount.

The monthly mortgage payments on these loans will be lower than any other type of financing instrument, making them appealing in high cost areas.

Start rates on negative amortization or minimum payment option loans can be as low as 1%, which is the payment rate, not the actual interest rate.

The adjustable rate feature is a key component of many NegAm loans. Most of these loans are straight adjustable rate mortgages (ARMs), meaning they're fixed for a certain period and adjust every time that period elapses.

For example, some NegAm loans are fixed for one month and then adjust every month. The interest rate is tied to a specific financial index, such as the Monthly Treasury Average, and is used in conjunction with a margin (the lender's markup).

There are also Hybrid ARM loans that have a period of fixed payments followed by an increased change cycle. This can be as simple as six months fixed and then monthly adjustable.

The graduated payment mortgage is a type of "fixed rate" NegAm loan, but it has aspects of an ARM loan since the payment increases over time until amortizing payments are required.

Here are some key differences between traditional and hybrid payment option ARMs:

Most NegAM home loans require full repayment of principal and interest according to the original term of the mortgage and note signed by the borrower.

These loans are often written in high cost areas, where the monthly mortgage payments will be lower than any other type of financing instrument.

Most loans only allow NegAM to happen for no more than 5 years.

If the borrower allows the principal balance to rise to a pre-specified amount, the loan can be recast to a fully amortizing schedule.

Start rates on negative amortization or minimum payment option loans can be as low as 1%, which is the payment rate, not the actual interest rate.

Payment shock is a real concern with negative amortization loans, as the required monthly payment can jump significantly from one month to the next. This can be particularly problematic if the borrower is not prepared for the increase.

It's not uncommon for borrowers to ignore or misunderstand the complications of negative amortization loans, especially when presented with minimal monthly obligations that are significantly lower than other mortgage products.

Negative amortization loans often feature teaser or artificial introductory interest rates or minimum loan payments expressed as a percentage of the loan amount. This can be misleading, as most mortgages do not feature teaser rates, and consumers may not be aware of the negative amortization side effect.

The potential for payment shock is highest in negative-amortization loans, which can lead to foreclosure or the need to refinance with a high loan-to-value ratio, resulting in additional monthly obligations and higher rates and payments.

To avoid negative amortization, it's essential to pay either the minimum required amount to pay interest or to pay more when available. Consistency is key, ensuring that payments are enough to start paying down the principal.

Here are some key facts to consider:

Negative amortization mortgage loans can be tricky to understand, but let's break it down with some real-world examples.

In a hot real estate market, a buyer might use a negative-amortizing mortgage to purchase a property with the plan to sell it at a higher price before the end of the "negam" period. This can be a great way to make a profit, but it's not without risks.

Mike, for example, obtained a mortgage when interest rates were historically low. His monthly payments were manageable, but they exposed him to greater long-term interest rate risk. If interest rates rise, Mike may struggle to afford his adjusted monthly payments.

A negatively amortizing loan is often referred to as "NegAm" or "deferred interest." It's a type of loan where the borrower pays less than the interest accrued each month, which can lead to a growing loan balance over time.

Mike's experience with a low-interest-rate mortgage is a real-world example of the risks of negative amortization. His monthly payments gobble up a significant percentage of his income, exposing him to greater long-term interest rate risk.

Negative amortization, also known as "NegAm" or "deferred interest", can cause a loan balance to decline more slowly than it would otherwise. This means Mike will have more principal and interest to repay in the future.

If future interest rates rise, Mike may be unable to afford his adjusted monthly payments.

Negatively amortizing loans are considered predatory by the federal government and were banned in 25 states as of 2008.

Their appeal is obvious: an up-front low monthly payment.

You should understand the terms of a negatively amortizing loan very clearly.

Be realistic about your ability to pay it off before deciding to take one out.