Negative amortization, is an amortization method in which the borrower pays back less than the full amount of interest owed to the lender each month. The shorted amount is then added to the total amount owed to the lender.
The home owner is not building equity in the house by reducing the mortgage balance, because the balance is growing each month instead of declining as with an amortized mortgage.
The main reason for negative amortization loans exist is to lower monthly payments. Some borrowers use loans with negative amortization to get into a house they otherwise can’t afford. Usually they believe that they’ll have more income in the future. While they have lower payments today, the cost of a negative amortization loan is that you have to pay more later.
Your loan payment is comprised by using the loan amount, the interest rate, and the number of years to pay back the loan. For a traditional mortgage, you pay enough each month to cover some interest and some principal. Because your payments with a negative amortization loan are not enough to cover the interest costs, the interest you didn’t pay is added to the loan balance.
If the loan balance increases while the market value of the property remains the same or declines then equity in the home wiped out. You can end up owing more money on the loan than the property is worth.
Negative amortization would have to be agreed upon before shorting the payment so as to avoid default on payment.
Negative Amortization is also known as deferred interest or Graduated Payment Mortgage (GPM).
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1 Fed Chief Suggests Lowering Mortgage Principal | Mortgage Foreclosure & Refinance Resource // Mar 4, 2008 at 10:16 am
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