Negative amortization occurs when your monthly mortgage payments are not sufficient to pay all interest and principal due on the loan. The unpaid interest is added to the unpaid balance of the mortgage. It could be considered borrowing equity from yourself. The period of time the neg-am is applicable is usually limited on each mortgage.
This type of mortgage is also sometimes known as a Graduated Payment Mortgage (GPM) or a deferred interest loan.
Negative amortization is not necessarily a "negative" thing. Home owners who understand its usefulness often benefit greatly.
A negative amortization loan is a rising balance loan. It differs from a fully amortized loan in that the payments made on a fully amortized loan are paying down a principal balance. A neg-am loan does not decrease the principal balance, it adds to it. This loan can be very useful for cash flow oriented projects in that the monthly payment can be fairly low.
When used properly, mortgage loans with potential negative amortization characteristics can be beneficial to homebuyers who want to pay as little in monthly payments as possible in the first few years of the loan term.
Credit card interest rates and payment plans are examples of negative amortization. Most credit cards carry high interest rates yet require a low minimum payment. By paying the minimum, the payment expectancy increases dramatically. Conversely, the low minimum payment allows you to allocate your payments to other debts or bills.
Neg-am or Negative amortization loan usually have a recast period to the loan conditions. Make sure that the recast period is 5 year or more. This will give you enough time to refinance if you are still in the loan. Contact a Mortgage Professional in regards to which lenders have a recast past 5 years.
A good characteristic of negative amortization is that your payment doesn't have to increase just because the interest rate on your ARM went up. The lender can also price the loan more aggressively because a payment cap doesn't mean that the lender can't pass along an interest rate increase. What's bad about 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.
In most cases, negatively amortizatized interest is tax deductible. Also, in many areas where these loans are being used, the appreciation of the home is far exceeding the deferred interest.
Most loans with a negative amortization clause will convert the payment to a principal and interest payment if the loan balance is at 115% of the original value of the property.
Some investors use Neg Am loans to increase their cash flow on a property. Usually they plan on selling or refinancing the property within a few years.
