How do negative amortization mortgage loans work?


Well, yes, many potential homeowners would like to know how negative amortization mortgage loans work. If you are thinking of buying a house it is good to know your options, and negative amortization mortgages are one of them, and a very attractive at that.

Explaining Negative Amortization Mortgage Loans

Here's how a negative amortization loan will work. You want to borrow money for a house, but want to have a very low monthly payment for a year, or two; or during winter if you have a seasonal business. You take an Option ARM (also advertised as a Flex loan, or Pick-a-Pay mortgage). With this kind of a loan your monthly payment can go as low as, say, 3%.

That is, if the loan rate is set at 6% you will be allowed to make interest only monthly payments as if your loan was set at 3%. The difference between the effective loan interest rate and minimum payment will be added to your loan balance and your loan balance will go up according to a preset negative amortization cap. After that cap is reached, of after several years the minimum payment option will no longer be available.

An Example of Negative Amortization Home Loan Schedule

Imagine your loan balance is allowed to grow with $20,000 and the deferred interest added to your loan balance monthly is $450. It will take approximately 45 months, or 3 years and 9 months, for your loan balance to reach that limit. Actually, if interest is accrued on the deferred interest, the cap may be reached even sooner. Make sure you ask the lender in writing when exactly the neg am loan cap will be reached and what your options will be afterwards.

After reaching the neg am mortgage balance cap, you might be allowed to make interest-only payments for some more time. Your options will be

  • Fully amortizing payments for preset mortgage term (usually 15 or 30 years);
  • Interest only payments for some more time and then fully amortizing payments;
  • Or, gradually increasing payments starting with interest and some principal.
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