Negative Amoritization Loans

Negative Amoritization Loans

Negative Amoritization Loans

Mortgage negative amortization can only occur with an adjustable-rate mortgage (ARM) when the interest rate adjusts more frequently than the borrower's payment adjusts, or the indexed interest rate rises faster than the borrower's monthly payment increases.

For example, most ARMs have monthly payments that are "locked" for one to 10 years. Many have fixed monthly payments for the first three to five years.

However, if the ARM interest rate adjusts monthly, semi-annually, or annually--although the borrower's monthly payment remains constant--if the interest rate rises, the unpaid interest is added to the mortgage balance.

The result is "negative am," meaning the borrower might owe more than was originally borrowed.

To illustrate, suppose the starting ARM interest rate is 5.5 percent and that ARM interest rate is based on an index rate, such as the Cost of Funds index, plus a "margin." Let's say the starting index rate is 3.5 percent and the margin is 2 percent, resulting in the 5.5 percent interest rate that could be locked for several years. If the index rises to 4.5 percent, but the borrower's payment remains fixed, the unpaid 1 percent interest amount is then added to the mortgage balance.

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Posted on December 29, 2005 01:12 | Real Estate
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