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Negative Amortization
Owing More Than Borrowed
Negative amortization
If your ARM includes a payment cap, be sure to find out about “negative amortization.” Negative amortization means that the mortgage balance increases. It occurs whenever your monthly mortgage payments are not large enough to pay all of the interest due on your mortgage.
Because payment caps limit only the amount of payment increases, and not interest-rate increases, payments sometimes do not cover all the interest due on your loan. This means that the interest shortage in your payment is automatically added to your debt, and interest may be charged on that amount. You might therefore owe the lender more later in the loan term than you did at the start. However, an increase in the value of your home may make up for the increase in what you owe.
The next chart uses the figures from the preceding example to show how negative amortization works during one year.
Your first 12 payments of $570.42, based on a 10% interest rate, paid the balance down to $64,638.72 at the end of the first year.
The rate goes up to 12% in the second year. But because of the 7½% payment cap, your payments are not high enough to cover all the interest. The interest shortage is added to your debt (with interest on it), which produces negative amortization of $420.90 during the second year
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Beginning loan amount = $65,000 |
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Loan amount at end of 1st year = $ 64,638.72
Negative amortization during 2nd year = $ 420.90
Loan amount at end of 2nd year = $ 65,059.62
($ 64,638.72 + $ 420.90)
(If you sold your house at this point, you would owe almost $60 more than you originally borrowed)
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To sum up, the payment cap limits increases in your monthly payment by deferring some of the increase in interest. Eventually, you will have to repay the higher remaining loan balance at the ARM rate then in effect. When this happens, there may be a substantial increase in your monthly payment.
Some mortgages include a cap on negative amortization.
The cap typically limits the total amount you can owe to 125% of the original loan amount. When that point is reached, monthly payments may be set to fully repay the loan over the remaining term, and your payment cap may not apply. You may limit negative amortization by voluntarily increasing your monthly payment.
Be sure to discuss negative amortization with the lender to understand how it will apply to your loan.
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This information is presented to help you make the important decisions involved in buying and financing your home. However it should not be viewed as all inclusive OR as a replacement for professional advice. Talk with attorneys, mortgage lenders, real estate agents, and other advisers for information about lending practices, mortgage instruments, and your own interests before you commit to a specific loan or action.
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