A mortgage that allows for the possibility of negative amortization usually attracts buyers through the fact that they include the option of making lower payments – sometimes when desired. Whenever a payment is made that is less than the amount of interest due for the month, the interest becomes added to the principal – which will ultimately raise the amount of interest each month. This causes negative amortization.
This type of option is usually given on an adjustable rate mortgage (ARM) called a payment option ARM. Some fixed-rate mortgages also have this option, and they are typically called graduated payment mortgages.
This type of mortgage made it easier for a family to obtain a mortgage larger than what they would be able to do otherwise. The intent was that they would have a larger income than when they got the mortgage, and would be able to make larger payments later. Generally, the possibility of negative amortization can only occur over the initial five-year period. At that time, the terms have to be recalculated, or recast, in order to make it fully amortizing.
Many people got into financial trouble during the economic problems of 2008. Some lost their jobs altogether, and those that were able to keep their jobs did not get the anticipated raise they needed to make the higher payments. This put many people in deep financial trouble, causing many to lose their homes.
Negative amortizing adjustable rate mortgages are still available. It is very important that you understand all of the terms that apply, as well as be familiar with all aspects of your mortgage, before signing on the dotted line. An adjustable rate mortgage can change monthly, quarterly, or annually. Also, be sure to learn what caps (limitations on the changes) are in place, if any. You also want to understand just how high it is possible for your payments to go if the economy should really go bad, and find out when your payments will become fully amortizing.
On a typical negative amortizing mortgage, the borrower can allow the balance owed to get as high as 110 to 115 percent of the original loan amount. Once this amount is reached, the option to pay a minimum amount is lost, and fully amortizing payments will be demanded.
Once the loan has expanded to 110 to 115 percent of the original size, the borrower now owes more than they did before. Payments will definitely become considerably larger, too, and the interest rates are most likely going to be higher.
This type of mortgage can be very good for someone who only plans to hold onto the house for five years or less. The goal would be to buy the house and then sell it before the fully amortizing payments become due. Although it is not enough time to build any home equity, the buyer can save money by making the minimum payment as long as possible. The problem with this is if the house does not sell and interest rates take off. This would leave the buyer with high payments, or the possibility of making interest-only payments for a limited time on some ARM's.
The negative amortizing adjustable rate mortgage now goes by a number of different names and some of the features may be different. Basically, though, it is a somewhat risky product. Interest rates will vary between lenders, which is a good reason why you should look around and get several mortgage offers first, and then carefully compare them for features that best fit your financial needs over the long run.
Karl Stockton often writes on finance, investment, real estate and current events. This article was penned for rbauction; for those interested in construction equipment, visit them to learn about their construction equipment.