Negative Amortization Loans
Negative amortization loans can come about for two reasons, one planned and one unplanned. The essential feature is that some of the interest due on the monthly payment is deferred, or in technical terms it is capitalized. The way to think of it is this: the monthly payment made on a loan or mortgage consists of two things:
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- The interest
- A repayment of some of the principal loan amount
If the payment is made up of interest and the amount necessary to pay off the loan in full divided by the number of months on the term, then it is fully amortizing. If it is enough to pay some but not all of the principal is it partially amortizing. But if the payment is not enough to even pay the interest, let alone pay off something of the principal, well, that’s a negative amortization loan.
This interest that you haven’t paid does not get forgotten, No, money unfortunately doesn’t work that way. It is added to the principal that you owe (which is what capitalized means). So the main feature of negative amortization loans is that the monthly payments are so small that the total amount you owe rises each month.
Such negative amortization loans can come about through chance. There are certain features of ARMs that can, in some circumstances, cause this to happen for a few months. More often they are planned this way, for at least the first few years at least. The aim is to make the payments lower in the first years of the mortgage thus increasing the affordability of housing (very important in markets like California) at the expense of higher payments later.
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