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. For example, the monthly mortgage payment on a level payment 30-year fixed-rate loan of $200,000 at 6% is $1200. In the first month, the interest due the lender is $1000, which leaves $200 for amortization. The balance at the end of month one would be $190,000. Suppose you only pay $800.
This can occur with flexible-payment loans which allow you, at times, to choose to make a payment that is lower than the monthly interest you incur. The difference in interest is then added to your loan balance. This is called negative amortization. If the value of your home does not increase, the amount of equity you have in the home decreases. However, this type of loan allows you to qualify for more home because the initial payments are substantially lower than those associated with a fixed-rate mortgage.
Negative amortization (also called Neg Am) occurs when a borrower is paying less every month than the interest on the principal. The $200 extra each month in the previous example is ADDED to the principal. That means that each month of negative amortization, the amount owed is increasing rather than staying the same or declining. Most loans that allow negative amortization have limits to the amount of principal that may be added before the loan must be restructured or a balloon payment must be made. Often, lenders who provide 2nd mortgages or a Home-Equity-Line-of-Credit (HELOC, pronounced “hee-lock”) will turn down a borrower who has a 1st mortgage that allows negative amortization.
” and explain how it can arise in amortization calculations and amortization schedules. I’ll try to illustrate the concept using a basic amortization table. For more information about the history of this term and how it applies to loans and mortgages, I recommend reading the articles listed in the references below.
