Negatively Amortizing Loan Definition

What Is a Negatively Amortizing Mortgage?

A negatively amortizing mortgage, generally referred to as a damaging amortization mortgage or damaging amortized mortgage, is one with a fee construction that enables for a scheduled fee to be made by the borrower that’s lower than the curiosity cost on the mortgage. When that occurs, deferred curiosity is created. The quantity of deferred curiosity created is added to the principal stability of the mortgage, resulting in a state of affairs the place the principal owed will increase over time as a substitute of decreases.

How a Negatively Amortizing Mortgage Works

Think about a mortgage with an 8% annual rate of interest, a remaining principal stability of $100,000, and a provision that enables the borrower to make $500 funds at a sure variety of scheduled fee dates. The curiosity due on the mortgage on the subsequent scheduled fee could be: 0.08/12 x 100,000 = $666.67. If the borrower makes a $500 fee, $166.67 in deferred curiosity ($666.67 – $500) will likely be added to the principal stability of the mortgage, for a complete remaining principal stability of $100,166.67. The subsequent month’s curiosity cost could be based mostly on this new principal stability quantity, and the calculation would proceed every month, resulting in will increase within the mortgage’s principal stability.

That is referred to as “damaging amortization,” and it can not proceed indefinitely. Sooner or later the mortgage should begin to amortize over its remaining time period. Sometimes, negatively amortizing loans have scheduled dates when the funds are recalculated, in order that the mortgage will amortize over its remaining time period, or they’ll have a damaging amortization restrict, which states that when the principal stability of the mortgage reaches a sure contractual restrict, the funds will likely be recalculated.

Particular Concerns for Negatively Amortizing Loans

Negatively amortizing loans are thought of predatory by the federal authorities and had been banned in 25 states as of 2008, in accordance with the Nationwide Convention of State Legislatures. Their enchantment is clear: an up-front low month-to-month fee. Nevertheless, they inevitably find yourself costing the patron extra—typically an excellent deal extra, as you find yourself paying curiosity on curiosity in addition to principal. It’s best to perceive the phrases of a negatively amortizing mortgage very clearly—and be lifelike about your potential to pay it off—earlier than deciding to take one out.