Negative Amortization Mortgages

It was a mortgage deal that you read or heard about, that just seems too good to be true.  A financial institution, bank or mortgage lender says they will allow you to make payments that are so small they do not even equal the current mortgage interest due.  This home loan programs would drastically reduce your monthly payments and you were on easy street.  Negative amortization mortgage are what this type of mortgage arrangement is called.  And it only sounds good in most cases.  Interest money you save now will cost you dearly later.

The typical monthly mortgage payment is mainly interest, charged for the use of the money you borrowed on the mortgage.  At the start of the mortgage term, almost all of the payment you make each month is paid in interest, with a small portion toward the principal of the home loan.  Over the period of the mortgage, gradually the amount paid toward the principal increases, and the interest you pay slowly decreases.  This process is the amortization of the mortgage loan.  A different type of home loan find mostly with adjustable rate mortgages is called a negative amortization mortgage and it is something not to be entered into lightly.

A negative amortization mortgage allows you to pay less interest for a set period of time, normally this may last for a few to several years.  Lets say for discussion that your normal mortgage payment each month is $1000, and of that amount $600 dollars goes toward the interest amount and the rest, $400 dollars goes toward the principal.  If you begin a negative amortization mortgage you would conceivably have the option to make a monthly payment of say, $500 dollars, which would pay on the interest and nothing on the principal of the loan.  You would still be responsible for the other $100 dollars of interest.  This other $100 dollars of interest is then added back into the principal of the mortgage loan, and you then will pay interest on this amount, too.

Negative amortization is made available by mortgage lenders by calculating two different interest rates.  The first interest rate is referred to as the payment rate and the second interest rate is simply known as, fully indexed interest rate.  On adjustable rate mortgages with negative amortization features, you will find that the payment rate changes are normally capped off at 7.5% of the previous payment amount.  However, the true interest rate is calculated by simply the adjustable rate mortgage index plus the margin without the use of periodic caps.  However, what the borrower pays is ultimately up to them because the borrower is able to choose which mortgage rate they wish to pay.  Because of this, you will find many amortization loans being advertised as “payment option” mortgage loans, due to the fact that you are given an option in how you wish you pay.  Even though the borrower is able to have flexibility in how they pay for their home loan, they are still subject to the true mortgage interest rate.

This results at the end of the first month actually owing more on your home mortgage than you did at the beginning of the month, and you pay increased interest on the difference until the mortgage is retired or paid off fully.

Short term lower monthly payments leads to short term gain.  Lower payments make it easy to qualify for a mortgage loan.  But it also leads to long-term financial pain.  You end up with more debt on your original mortgage than you started with and greatly increased mortgage interest payments.  The longer that you are in a negative amortization mortgage, the greater sum of money you will wind up paying on your mortgage.

There are times that a negative amortization mortgage makes good sense because of the easy mortgage qualifications and lower monthly mortgage payments.  But this is true only in certain cases.  If you run into financial trouble, or sudden and unexpected expenses you cannot avoid.  Or you are laid off of work and can’t find a job right away, in such cases a negative amortization mortgage may make sense.  Entering into a negative amortization mortgage due to necessity or with the knowledge down the road you will be on better footing financially is sometimes a positive choice.  Once your situation changes you can arrange to make either additional or increased monthly mortgage payments to take up the slack.  Or, if you have the money you might pay it all off at once.

Some people use the undemanding qualifications and lower payments to pay for a house while the value of the real estate increased.  In such cases a person may choose to live inexpensively in a house while it appreciates in value, then sell later and realize a profit.  The profit can then be used to pay off the mortgage.  But if the property does not increase in value or appreciate then you may be saddled with a large expensive mortgage and no way to pay it off.  Another valid use was for young couples to use the adjustable mortgage rate feature for easy qualification on tight income or budget.  The appeal would be that as young workers their income was more likely to increase rapidly in the ensuing years and handling the negative amortization feature in order to buy the house was reasonable trade off.

There is the chance that, as in life, your financial situation may not improve on the time schedule you anticipated.  When this happens you can be faced with some very tough decisions and possibly being forced to sell your home or property.

The mortgage calculators designed to evaluate adjustable rate mortgages can be very useful in analyzing the mortgage payments on a negative amortization home loan.  In addition, the mortgage calculator can be very useful in viewing future mortgage rate changes and how they will impact the monthly mortgage payment as well as the total amount of negative amortization that will take place when the mortgage rate rises and the payment is capped.

It is a risky business, so think carefully before entering a negative amortization mortgage.  It can be attractive to help cope with some situations, but it assumes a large amount of risk and should be avoided if possible.  These home loans are available for both a home purchases and an existing mortgage refinance.