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Negative Amortizing Mortgages
Negative Amortizing Mortgages
Some mortgages are written to include payments that are less than the interest payment for that period. This creates a negative amortizing effect. Or in other words the interest that accrued (and wasn't paid off) was added to the principal. In the next period the interest that was added to the principal is now used to calculate the new interest payment. When this occurs the amount of interest due and principal increase simultaneously.
At first glance a Negatively Amortizing Mortgage seems like a bad idea. It seems like the longer you have this type of mortgage the deeper you get into debt. This is true but there are several reasons to carry a Negatively Amortizing Mortgage for both Fixed Rate and Adjustable Rate Mortgages. In either instance it's always a good idea to ask the right questions and know what is going to happen throughout the life of the mortgage.
In terms of a Fixed Rate Mortgage a negative amortization allows the borrower to have a lower introductory payment. This is beneficial if the borrower anticipates selling the home within a short period of time or expects to be making more money in the near future. The downside is that future payments, at some point, will have to increase to compensate for the period of low payments. This isn't a problem if the borrower knows in advance what the payments will be and anticipates being able to afford them or is able to sell the house for a profit (a profit must be made to compensate for the negatively amortized amount).
A Negatively Amortizing Adjustable Rate Mortgage is used to both mitigate payment increase shock and for investment purposes. An Adjustable Rate Mortgage can sometimes send mortgage payments skyrocketing in a volatile market. With a Negatively Amortizing Mortgage the payment changes very little or not at all. The downside to this is that the amortization (the amount being paid off) slows down or reverses altogether. From an investment perspective someone that intends to flip a house or purchase a house for other investment opportunities typically wants to make more money and spend less. With a Negatively Amortizing Adjustable Rate Mortgage the borrower can have the lowest possible payments as well as have the right to sell the home for a profit before too much negative amortization occurs. This is especially valuable when a home is purchased for less than its worth or rapidly increases in value.
In conclusion, a Negatively Amortizing Mortgage is beneficial for someone who expects to be able to make higher payments at a later date or for a savvy investor. Before signing on the dotted line make sure, as a borrower, that you know all of the ins and outs incorporated in your Negatively Amortizing Mortgage.