A negative amortization loan is a loan where the monthly payment does not decrease your loan principal. In other words the payment being made doesn’t pay back the principal on the loan. In fact the payment being made doesn’t even cover the minimum monthly interest payment. As a result your home mortgage will increase overtime.
How does it work?
Well, your monthly payment is composed by the loan amount, interest rate, and the years that the loan will be paid back. Normally a mortgage payment will include sufficient money to be applied towards interest and principal, in order to effectively reduce the balance on the loan. In a negative amortization, you don’t even pay enough to cover the interest being charged by the bank.
What does negative amortization mean to you?
Since the payment in a negative mortgage doesn’t even cover the minimum interest charge, the amount that wasn’t paid gets attached to the principal balance (loan balance will increase with every payment). In other words, every time you make a negative amortization payment it’s like you’re taking out another loan on your home. When you amortize a loan it simply means that you’re paying it off, therefore the name negative amortization is given to this particular situation.
What is the practical use of a negative amortization?
The main purpose of this type of amortization is flexibility in payments. This type of amortization was designed with a certain type of borrower in mind. Normally this is a type of payment that is suggested for people without regular income, such as commission employees and business owners. The idea is that people without regular income might have a down month where making a full payment is not likely to happen, instead of missing a payment they would have the option to apply the minimum amount, avoid missing a payment, and add the rest to the back of the loan. On the opposite side, if they have a good month then making a bigger payment is also possible in order to catch up on the negative amortization months, thus allowing the borrower to pay off the principle balance.
Keep In Mind:
This type of amortization is not for every home owner, as time goes on and more negative amortization payments are made, the larger the amount of money that will be owed by the borrower to catch up the loan.
