Negative amortization, also known as Neg Amortization, NegAm, NegAmMort, occurs when borrower pays back less than the full amount of interest owed to the lender each month. The difference betweeen full interest and paid amount is added to the total amount owed to the lender.
Also known as deferred interest or Graduated Payment Mortgage (GPM).
The purpose of loan with negative amortization feature is to increase affordability, or add payment flexibility to a loan. This loan is popular in high cost areas, because the monthly mortgage payments will be lower than with any other type of mortgage.
Negative amortization loans can be high risk loans for inexperienced investors. NegAm loans are mostly Adjustable Rate Mortgages or ARM loans with rate based on one of the index rates (LIBOR, T-Bills etc.). Most COFI, CODI and "Option payment" loans often imply negative amortization if borrower repeteadly choose to pay minimum payment rather than fully amortizing payment.
These loans tend to be safer in a falling rate market and riskier in a rising rate market.
All NegAm home loans designed to allow Negative Amortization to happen for no more than 5 years, and have terms to recast the payment to a fully amortizing schedule if the balance rises over a pre-specified amount.
NegAm - Mortgage Terminology
Cap - percentage rate of maximum change in the NegAm payment. Cap defines how quickly the NegAm payment can grow in a rising market.
Period - how often the NegAm payment changes.
Recast - premature stop of loan. Should negative balance reach a predetermined amount (typically 115% of the original balance) the loan will be "recast" with one payment option: principal and interest in high enough amounts to amortize the loan balance in the remaining years of your mortgage.
Stop - end of NegAm payment schedule.
With NegAm Loan you can afford bigger mortgage than with 30 year loan, or fully amortized ARM loan, but, the danger of negative amortization is that the home buyer may ends up owing more than the original amount of the loan.