"What is Negative Amortization?"

Negative amortization means that your loan balance is increasing instead of decreasing. With a negative amortization loan, when your monthly payment on an ARM (adjustable-rate mortgage) isn't enough to cover the interest expense and principal payment, the shortage is added to your loan balance. This situation arises when the adjustable-rate mortgage has a payment cap but the interest rate on the mortgage has increased. Ordinarily, the mortgage payment you make to the lender has two parts: interest due the lender for the month, and amortization of principal. Amortization means reduction in the loan balance the amount you still owe the lender.

When is a negative-amortization loan a good idea?

Negative amortization is less likely to occur in rapidly appreciating markets. In markets where prices are stable or dropping, it is possible to end up with a loan balance that is higher than the market value of your home. Adjustable rate mortgages with payment caps and negative amortization are usually re-amortized at some point so that the remaining loan balance can be fully paid off during the term of the loan. This could necessitate a substantial increase in the monthly payment. Most ARMs have a limit on the amount of negative amortization allowed, usually 110 to 125 percent of the original loan amount. If the loan balance exceeds this amount, the borrower has to start paying off the excess.

Negative amortization can be avoided by paying the additional interest owed monthly. ARMs that don't have payment caps usually don't have negative amortization.

Can I convert a negative-amortization loan to a regular loan?

Loan terms vary and each agreement needs to be reviewed carefully. Talk to your lender about specific situations. Negative amortization occurs when monthly payments on a loan are not enough to pay the interest accruing on the principal balance. The unpaid interest is added to the principal due.

The problem with negative amortization is that the payment will eventually reset to a level to allow the loan to amortize over its remaining life. The increase in the monthly payment needed to repay the larger loan over a shorter time span can be substantial. If rates have increased substantially, then refinancing may not be a viable option. Lenders will hesitate to refinance your loan if you do not have any equity in your home. Lenders evaluate their risk by looking at how much equity you have in your home. They feel more comfortable if you have built equity.

Another major problem is that real estate prices may not continue to increase, especially if interest rates start trending higher. Being upside down in a mortgage loan (you owe more than what the home is worth) because of negative amortization isn't pretty if you need to sell your house. Negative amortization can be avoided by paying the additional interest owed monthly.

 

Andre Plessis

It's All About You!