Refinancing Of A Home Mortgage

Refinancing of an existing home loan basically means shifting your loan account to another financ...

Nitty Gritties Of Buying Foreclosed Homes

Buying foreclosed homes is the in thing today. With the economic recession hitting the market, th...

Home Mortgage Interest Deduction

Mortgage Forgiveness Debt Relief Act of 2007

Negative Amortization: Pros and cons

by: sahil | last updated: April 17, 2010
Category: Personal Finance | Tags: Negative amortization, home buying, mortgage, ARM, adjustable rate mortgage, graduated payment mortgage, home loans

Guide Rating:

Your Rating:
- 1
- 2
- 3
- 4
- 5

0 comments |

Email this guide |

Print this guide

Negative Amortization: Pros and cons

A negative amortization is a type of loan in which the owed balance increases over the period of loan. You as a borrower are not making any payments towards the principal initially in such type of mortgages. Sometimes such loans are comparable to graduated payment mortgages and are also referred to as NegAm loans. Amortization simply means reduction in something and negative amortization means even as you pay the owed balance goes on increasing; hence the prefix “negative”.

These types of loans may seem unfeasible at first glance but the exact opposite is true. These types of loans and mortgages are used by people or borrowers who want to pay very low monthly payments and buy a house or something they couldn’t afford if negative amortization was not present. This also means that since the payments don’t even cover the interest; the borrower has to keep making payments even after the completion of the term of the loan.

NegAm loans are very similar to adjustable rate mortgages (ARM) in which the interest rate is tied to a financial index and is adjusted periodically. Many may confuse Negative amortization with reverse mortgages in which the equity in the home is sold by the owner to receive periodic or lump sum payments till he or she leaves, sells the house or dies. In a negative amortization the low payments do not absolve the borrower from paying the whole amount; i.e. principal plus interest.

Many people and investors use negative amortization as an investment strategy in the real estate market. This is also due to low payments and the belief of people that values of residential properties will increase over time. This investment strategy may prove risky since as observed recently in the wake of the sub-prime mortgage crisis, the value of residential properties does not always increase.

There has been considerable criticism of such loans and the workings of negative amortization. Such amortization can bring about what is known as a payment shock for borrowers where the monthly payments jump so high that they virtually become unaffordable. Another criticism is that in a market where prices of real estate are increasing speculators may buy properties through such mortgages and sell them for exorbitant profits before the end of the NegAm period.

Negative amortization requires full payment of principal plus interest eventually. However this means that such instruments are feasible in areas where the cost of real estate is high and the borrower expects some earnings or income over a long period of time. This can be a good option for middle and higher middle class families and people since the cost of residing is high but initial monthly payments are low.