Negative Amortization

Negative amortization is a phenomenon in which the principal balance on a loan increases every month, rather than decreasing with each payment. because the payment fails to cover the payable principle and interest . For Instant, when someone makes a loan payment, that payment is used to pay off the interest which has accrued, and the remainder of the payment is applied to the principal. In the early stages of the loan, the payments often go almost entirely to interest, with a small fraction going to the principal.

As a result, at the end of each month, the unpaid amount is added to the balance of the loan, causing it to increase. when a lender would consider providing a loan with negative amortization is when the assets securing the facility are determined to have significant equity value.


These loans have many names: Negative Amortizing Loan, Neg Am or NegAm, Deferred Interest Option Loan and Pay Option Arm.

Characteristics of Negative Amortization

Amortization means to reduce something over time. A negative amortization loan actually increases your loan over time. In the negative amortization loan system, the periodic payment doesn’t include the interest amount due for that period of loan. The result of this type of loan is that the principal or loan balance gets higher by the unpaid interest amount. Negative amortization loans can involve high risks for the investors. Negative amortization is also a term used for Graduated Payment Mortgage (GPM).

Negative amortization loan is sometimes the best for homebuyers who have very little to contribute toward a monthly payment. and Sometimes it is also a good choice for investors who are not planning on holding onto the home long enough for the loan value to really boost. But it is not a good loan program for everyone, especially for those who are planning on living in their home for a long time. The biggest disadvantage of negative loan amortization comes when the homeowners want to sell their home. If they’ve lived in it for several years while paying on a negative amortization loan, it’s possible that the loan amount has become larger than the amount that they can actually sell the house for.

Reasons to choose Negative Amortization

Lenders and borrowers will sometimes knowingly take out a loan with negative amortization, and sometimes it happens as a result of market rate interest trends. Some reasons that borrowers and lenders may end up with a negative amortization loan.

It may be attractive for a borrower to have a lower monthly payment at the beginning of the mortgage loan. The lender may want to allow a negative amortization loan to a borrower based on their future income, and a borrower may want to have lower monthly payments now because they are expecting their income to greatly increase in the near future.

A reverse mortgage creates negative amortization because no payments are ever made and all of the interest is added to the principal of the loan.

It is an Adjustable Rate Mortgage and the interest rate grew higher than the payment cap. With Adjustable Rate mortgages there is usually a cap to how high the monthly payment can get.

Problems with Negative Amortization

The entire amount of the loan amortization must be paid at last. This is why most banks and financial institutions do not allow a negative amortization period of more than five years. In addition, the terms and conditions of the loan will also have to be readjusted if the principal balance reaches a predetermined amount. This is to prevent borrowers from taking advantage of negative amortization and making their loans drag on for a long period of time.

The resultant payment shock is proportionate to the amount of negative amortization and the period over which it occurs. Thus, the more attractive the loan is upfront to the borrower  the larger payment shock will need to be to fully amortize the loan.

You might also like

Negative Amortization Loans Everybody prefers to pay and get rid of their loans as quickly as they can but the system of loans is...
Mortgage Amortization and GPM,A Comparison A mortgage is a secure form of debt instrument in which the underlying is usually the real estate property.The...
Dangers Inherent in Payment Option ARMs Nearly all credit markets were brought to a standstill in the 2007 and 2008 due to poor underwriting...
How To Manage Your Mortgage Refinance And Payback Period When a lender gives a loan to you whether its a bank or any other financing institution then they would...
Negative Equity Equity is an accounting terminology and it means that sum of all assets that you have, including your...
Debt Consolidation Companies

People who liked this Post also read

  • The Story of Success and Failures of New Century Financial
    The Newcentury Financial Corporation achieved a name in real estate financing in very short tenure, and becomes the 2nd larget in the field. However they failed to keep their success for the reasons of improper practices and unsecured loans. However there...
  • Does Reverse Mortgage Really Work?
    Reverse mortgage explains the term and defines the implications that mortgages can have. It also explains about the appropriate people that would be suitable for such type of loan and advises, the people in need of mortgages, especially the retirees that ...
  • Dangers Inherent in Payment Option ARMs
    ARMs were intended to borrowers with irregular income. However, when these borrowers in year six find it hard to refinance their mortgage due to negative equity may be tempted to walk away from the home, leading to lose to the investor....
  • Reverse Mortgage for Retirees
    Reverse mortgage loan is a great tool for retirees to build up funds for their life after retirement. Reverse mortgage loan is of various types, some of the types are secured by the government while others are not. It creates various ways to generate inco...
  • A Safe Haven for Real Estate Investors-Canada
    Canada is a very safe place for real estate investors. There are very liberal laws that allow even the non-residents to own property in the country. The only thing that you need to consider carefully is the Canadian tax laws....

is an experienced IT Consultant turned Blogger, Interested in Technology, Personal Finance, Humans and Life...You and discover more about him by following RMak on twitter.

Leave a Reply

© 2011 Loan Mortgage Credit!. All rights reserved.