Real Estate Guide

Your Mortgage - Questions and Answers
'Negative Amortization'

• What is negative amortization?
• When is a negative-amortization loan a good idea?
• Can I convert a negative-amortization loan to a regular loan?

What is negative amortization?

Negative amortization occurs when the monthly payments on a loan are insufficient to pay the interest accruing on the principal balance. The unpaid interest is added to the remaining principal due.

When home prices are appreciating rapidly, negative amortization is less of a possibility than when prices are stable or dropping, particularly for the borrower who made a small cash down payment to begin with. The combination of negative amortization and depreciation in home prices can result in a loan balance that is higher than the market value of the home.

Negative amortization can be avoided by paying the additional interest owed monthly. ARMs that don't have payment caps usually don't have negative amortization.

When is a negative-amortization loan a good idea?

Some experts would say negative amortization always too risky, however,  negative amortization is less likely to occur in rapidly appreciating markets. In markets where prices are stable or dropping, it is possible to end up with a loan balance that is higher than the market value of your home.

In the real estate go-go years 2000 through 2005 negative amortization became a popular way to finance ever appreciating (it seemed) homes. However, when the bubble burst in 2006 thousands of homeowners found themselves in homes that were worth far less than what was owed. As their Adjustable rate mortgages with payment caps and negative amortization re-amortized to a higher monthly payment, these same homeowners were no longer able to meet the monthly payments, nor sell for enough money to pay-off the mortgage. Their only choice was often foreclosure.

Can I convert a negative-amortization loan to a regular loan?

Loan terms vary and each agreement needs to be reviewed carefully. Talk to your lender about specific situations.

Adjustable rate mortgages with payment caps and negative amortization are usually re-amortized at some point so that the remaining loan balance can be fully paid off during the term of the loan. This could necessitate a substantial increase in the monthly payment.

Most adjustable rate mortgages have a limit on the amount of negative amortization allowed, usually 110 to 125 percent of the original loan amount. If the loan balance exceeds this amount, the borrower has to start paying off the excess.