Negative amortization
In
finance,
negative amortization, also known as
NegAmMort, is an
amortization method in which the borrower pays back less than the full amount of interest owed to the lender each month. The shorted amount is then added to the total amount owed to the lender. Such a practice would have to be agreed upon before shorting the payment so as to avoid default on payment. Also known as
deferred interest or
Graduated Payment Mortgage (
GPM).
=Defining Characteristics=
Negative amortization would only arise on loans with the following features:
* The minimum installment payment due does not cover the amount of interest due on a loan. As a consequence, the balance rises. The purpose of such a feature is to increase affordability, or add payment savings and payment flexibility to a loan.
All NegAM home loans eventually require full repayment of principal and interest according to the original term of the mortgage and note signed by the borrower. Most loans only allow NegAM to happen for no more than 5 years, and have terms to "Recast" (see below) the payment to a fully amortizing schedule if the borrower allows the principal balance to rise to a pre-specified amount.
This loan is written often in high cost areas, because the monthly mortgage payments will be lower than any other type of financing instrument.
Negative amortization loans can be high risk loans for inexperienced investors. These loans tend to be safer in a falling rate market and riskier in a rising rate market.
NegAM loans today are mostly straight
Adjustable Rate Mortgages (ARMs), meaning that they are fixed for a certain period and adjust every time that period has elapsed; e.g., One month fixed, adjusting every month. The NegAm loan, like all Adjustable Rate Mortgages, is tied to a specific financial index which is used to determine the interest rate based on the current index and the margin (the markup the lender charges). Most NegAm loans today are tied to the Monthly Treasury Average, in keeping with the monthly adjustments of this loan. There are also Hybrid ARM loans in which there is a period of fixed payments for months or years, followed by an increased change cycle, such as six months fixed, then monthly adjustable.
The
Graduated Payment Mortgage is a "fixed rate" NegAm loan, but since the payment increases over time, it has aspects of the ARM loan until amortizing payments are required.
*
Cap - percentage rate of change in the NegAm payment. Each year, the minimum payment due rises. Most minimum payments today rise at 7.5%. Considering that raising a rate 1% on a mortgage at 5% is a 20% increase, the NegAm can grow quickly in a rising market. Typically after the 5th year, the loan is recast to an adjustable loan due in 25 years.
*
Life Cap - the maximum interest rate allowed after recast according to the terms of the note. Generally most NegAm loans have a life cap of 9.95%.
*
Payment Options - There are typically 4 payment options:
** Minimum Payment
** Interest Only Payment
** 30 Year Payment
** 15 Year Payment
*
Period - how often the NegAm payment changes. Typically, the minimum payment rises once every twelve months in these types of loans.
*
Recast - premature stop of NegAm. Should your negative balance reach a predetermined amount (typically 115% of the original balance, or 110% in New York)) your loan will be "recast" with one of two payment options: the fully amortized principal and interest payment, or if the maximum balance has been reached before the fifth year, an interest only payment until the loan has matured to the recast date. (typically 5 years)
*
Stop - end of NegAm payment schedule.
