NEGATIVE AMORTIZATION LOAN
There are many names given to this type of loan such as; option-arms, negative arms, pick-a-pay, flexi-pay, etc. A negative amortization loan is a mortgage repayment plan in which the homebuyer has a choice to make monthly payments that are less than the minimum amount of interest due. The difference in interest is then added on to the outstanding amount due, which results in an increase in the loan balance. You should then ask yourself if with each mortgage payment you make, is the principal being reduced or is the principal increasing? If the principal is increasing instead of decreasing then you should think carefully on the future financial implications. You will have to pay more than you borrowed to liquidate the debt.
Here is an example of the options you may see on a mortgage statement. Please keep in mind there are so many Lenders that offer this program, so each statement looks different. They all have lines showing payment options. We want to show you what a typical four (4) payment option may offer (a three payment option generally removes the top option):
15 Year Payment $871.11
30 Year Payment $632.07
Interest Only Payment $541.66
Minimum Payment (most popular is 1%) $321.64
By paying the 1% option each month, the difference has to be placed on the loan balance.
Interest Only - $541.66
Less Minimum Paid - $321.64
Difference in payment: $220.02
So if you started out with a $100,000 loan, your next month after making the minimum payment you would owe $100,220.02. And by the end of the year you would owe approximately $102,640. Think of what may happen in 5 years.
The problem is that once the 1% option disappears (typically within 5 years), the loan balance may reach 110-125% of the original loan amount. So, to avoid the negative amortization, the borrower must make at least the interest only payment. The principal will then remains at $100,000.