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Negative Amortization Mortgage: Pros and Cons


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TERMINOLOGY

A negative amortization mortgage loan is usually an adjustable rate mortgage, or ARM, on which the monthly payments are less than for a traditional mortgage loan. When you take out a traditional mortgage loan, you pay principal and interest each month. If you have a negative amortization loan, the amount you are required to pay will not even cover the total monthly interest on the loan. Any unpaid interest then gets added back into the loan balance. There is usually a limited number of partial interest payments allowed until the loan converts to a traditional mortgage. The lender may also set a maximum interest amount that can be added to the loan balance, regardless of the number of payments you have made. You should consult with an experienced lender as well as your financial advisor or other professional before you decide to use a negative amortization loan.

Pros

Many borrowers use a negative amortization mortgage loan so the excess cash they save from the low monthly payment can be invested in an instrument that pays higher interest than the loan rate. They may also use this type of financing because they intend to sell the property shortly after they purchase it.

When you are unable to afford a certain home due to a high monthly payment, if you qualify for a negative amortization loan, you can then buy the more expensive home since your payment will be lower. If the home increases in value during your negative amortization period, you may be able to sell it for a large profit since the payments you made were much less than for a traditional mortgage loan.

Cons

If you do not make any reductions to your principal loan amount during your negative amortization period, the amount of your balance will be more than what you originally owed at the time of the loan’s origination. When the partial payments are over, your monthly payment may then become unmanageable, which can force you into selling the property for a loss if the market is soft at the time.

Most negative amortization loans, being ARMs, have an annual adjustment period to the rate. The rate can go up or down depending on market conditions at the time of the adjustment. There is usually a limit to how much interest can be added to the original principal amount. If rates have gone up, you may reach the maximum amount of interest allowed faster than you anticipated when you took out the loan. This will result in the end of your negative amortization period, forcing you to refinance prematurely.

If you took out a negative amortization loan intending to sell the property for a quick profit, you may have negative emotions if you are unable to find a buyer. The longer it takes you to sell, the more anxious you may become. This can lead to your accepting an offer that may be less than the true value of the property.