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Negative Amortization
Added: 12/23/2004 Type: Summary Viewed: 637 time(s) [ Not Rated Yet ]

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Negative Amortization

December 23, 2004 -- Mortgage terms have always been confusing. This is an attempt to get the Negative Amortization process clear to you.

Amortization is the process of repaying the principle borrowed in full within the term settled on .But as the term ‘negative’ is added to amortization it brings shiver down the spine of mortgagors.

Negative amortization is the process whence, the principle goes on increasing because of repayments amounts smaller than the interest accrued . This causes the loan balance to increase. The question which might strike you is- why should the balance increase in spite of repayments?

The fact is – the mortgage payment is divided into 2 parts-
•An interest payment depending on the FRM or ARM opted for a month
•The principle amount

Let us take for instance; Ron had mortgaged his property for $100,000 at 5% for a 30- yr fixed rate. In the first month, monthly repayment would be $500. Out of which $400 would be the interest due and $100 for amortization. So, the balance at the end of a month would be $99,900

If Ron pays this amount throughout the term regularly, his loan would be paid off.

But if he pays $450, the amortization will only be partial, leaving a balance.

Say, he pays $400 alone it would be interest –only mortgage.

And if he pays $300 it would be lesser than the interest and the loan balance would increase to $100,100 .This is called negative amortization.

When does it occur?
It arises only with ARMs with:
•When the initial amount is lesser than the interest due
•When the interests rate adjusts more frequently than the monthly payment.
•Monthly payment is capped

But the above three feature are advantageous too.

Who does not want to pay less?
For most families the largest amount of money goes into the mortgage payments bracket. So, to pay less initially the first option is used.
Secondly, with adjustable rates the interest keeps fluctuating and one can avoid the constant changes in interest paid.

Thirdly, the payment cap is imposed to prevent the ARM monthly payment from rising beyond a certain limit.

What disadvantages does it bring?
With negative amortization the equity of your house will decline consistently as the liability is increasing. This could only be offset by house appreciation.

The ARM limit is not designed to protect the mortgagor but the lender. If the limit is crossed, he can easily add the amount to the principle regardless of how large the amount might be. With fluctuating rates one need not increase the amount to be paid.

The negative mortgage cap overrides the payment adjustment cap because it is applicable in constantly increasing interest rates over a long period.

If you opt for ‘neg-am’ you must understand the concept in full. if you allow it to continue , the balance might even climb above your home value . Thus you should opt for increased payments after the initial low amounts to fully amortize the loan.

Otherwise, the larger the amount of neg-am , the longer period it would take and more money too will be required for repayment.

Untoward expenses may crop up and this might result in low monthly repayment. But steps must be taken to compensate otherwise neg-am can turn you bankrupt. So, all you need to know is grasp the concept and change strategies according to the situation and aim to repay the amount within the term.

For further details please visit our site
http://www.mortgagefit.com

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