Negative Amortization

Bruno Simpson Last Updated Jul 09, 2019 (0) comment

Negative Amortization

Amortization is the paying off of a loan with regular payments which cover the principal and interest rates. With each payment, the loan is paid off and never increases. With many conventional loans, borrowers are given a schedule of payments. Each month, a certain amount is due and the schedule outlines how much of that payment is eventually attributed to the principal and how much to the interest. Of course, mortgage insurance, taxes, and other costs are also calculated into most mortgage payments as well.

In loans with negative amortization payments the principal of the balance increases before it decreases. Essentially a borrower is offered a schedule of payments where the initial payments are lower than the interest or pro-rated principal. Because a monthly payment substantial enough to cover the monthly breakdown of interest and principal is deferred, over time the principal of the loan grows.

Also, since the principal grows with each payment rather than shrinks, eventually interest is added upon the growing principal balance. At some point, the borrower will have to start making larger payments that will start paying down the loan.

Eventually, the borrower will have to increase their payments to start covering the interest and principal on the loan. The sudden and eventual spike in payment amounts makes negative amortization risky for both the lender and borrower. However, Negative Amortization is attractive to some borrowers precisely because of the lower initial monthly payments in cases where the borrower is expecting an increase in income for whatever reason.
The eventual spike has proven to be the highest cause of loan default with negative amortization so after 2010, with widespread of loan defaults, loans with complicated payment schedules are not as so readily available. As a result, this type of payment system is now rare, and becoming rarer as lending regulations tighten. However, some mortgage lenders are beginning to offer a new loan product called Interest Only- Mortgage in its place.

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