How does Negative Amortization Mortgage Loans Work ?
Well, most home owners who have owned a home hopefully knows how a mortgage actually works. The monthly loan payment is nothing but calculating the loan amount, interest rate and the term (number of years) to pay back the loan. So every conventional mortgage loan consists mainly of interest due each month and the amortization of the principal. Amortization in mortgage world simply means the gradual reduction of principal.
Mortgage products have always been creative to suit the market trends and the ongoing borrower needs to own a home. After all it is every American’s Dream to own a home. With that said and home prices being so high, lenders have come up with loans to make payments more affordable and comfortable for the borrower. One type is an interest only loan where you typically pay interest for the first five or 10 years. Then, there is a payment increase that brings the loan to its fully-amortizing level.
The other type is a deferred interest loan, also known as a payment option ARM (adjustable rate mortgage) and the borrower typically when it comes to mortgage loans has four payment options: a minimum payment that only covers part of the interest, an interest only payment option, a fully-amortizing payment option and a payment option that lets the borrower payoff the loan early.
Typically, borrowers choose the minimum payment option, which are not enough to cover both the interest and principal payments on the loan, so the shortage is added to the loan balance, which is why these loans are also known as negative amortization loans. According to mortgage gurus, negative amortization occurs when :
- The initial payment does not cover the interest due. The ultimate purpose of such a feature is to increase affordability of buying a home.
- The interest rate adjusts more frequently than the monthly payment. The purpose of this feature is to avoid frequent changes in your monthly payment.
- Changes in the monthly payment are capped, usually at 7.5%. The purpose is to avoid large changes in the payment.
In comparing negative amortization payments vs interest only payments, interest only payments may cost a little more each month, but the payment increase to make it a fully-amortization loan isn’t nearly as bad because you don’t have to make up any principal shortfall as you would with payment option ARMs. So, if you’re looking to increase your purchase power on a high-priced home, consider an interest only loan rather than a payment option ARM.
If your first mortgage is a negative amortization loan, try to refinance before your payments increase. If you have a negative amortization second mortgage, you should refinance the second mortgage. The interest rates are low and have pretty much leveled off probably to the end of the year, so fixed rate loans would be your best bet. Take advantage of the lowered interest rates and refinance now.
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