NewswireToday - /newswire/ -
New York City, NY, United States, 2006/12/13 - Negative amortization is why these option ARM loans have been blasted by the media and consumer groups. Other reasons include some mortgage brokers not offering full disclosures, or the borrower is misinformed and uneducated about deferred interest.
With most home loans, each monthly payment goes towards paying interest and part of the principal balance. As you make payments over the years, the principal balance of your loan slowly decreases. This process is called "amortization". A negative amortization mortgage, also known as a deferred interest loan, payment option ARM (adjustable rate mortgage), pick-a-payment mortgage, Neg-Am and other descriptive terms, allows you a choice of payment methods, including a minimum payment based on a below-market "payment rate" which doesn't cover your interest. Instead, the shortfall is added to the principal balance, causing it to rise (negative amortization).
Investopedia.com says, “the bad thing about negative amortization is that eventually, the mortgage payments may need to increase to allow the larger loan amortize over its remaining life. Thus, the increase in monthly payments can be significant.”
Negative amortization is why these option ARM loans have been blasted by the media and consumer groups. Other reasons include some mortgage brokers not offering full disclosures, or the borrower being misinformed and uneducated about payment option ARMs. For example, many people don't understand that their loans will not only recast (have a payment increase) when their principal balance reaches between 110% and 125% more than the purchase price, but there is also a secondary, regularly-scheduled recast of monthly payments. At a set interval, usually five years, the lender will adjust the borrower's monthly payment to be fully reflective of the remaining balance at today's market interest rate, which can cause a measurable increase in monthly payments.
Another thing to consider is that it is difficult to get a second mortgage behind a neg am loan. If you're in the market for a home in a high-priced area like Arizona or California, you may want to consider an interest-only loan instead of a Neg-Am. When comparing negative amortization payments versus interest only payments, you'll find that the payments for interest-only loans aren’t that much higher than those for Negative amortization loans. Interest-only loans typically allow you to pay interest only for 5 years before recasting into an amortizing loan. The payment shock is not as bad for these as for pay option loans because the principal balance doesn't increase.
With some 80-20 (piggy back) loans, the second mortgage may restricted by the negative amortization 1st mortgage. If your piggyback 1st mortgage is a Neg-AM loan, then you may have a difficult time refinancing the second mortgage, because most lenders do not allow second mortgages for refinancing purposes behind payment option ARM's.
Bridge Mortgages (bridgemortgages.com) offers 100% home financing for qualified homebuyers seeking no money down home financing. We offer competitive rate quotes for home equity loans and payment option mortgages with interest only and deferred interest options.