Negative amortization: An increase in the balance of a loan resulting from a failure to cover the interest due.
Negative amortization: Negative amortization, also deferred interest or graduated payment mortgage, occurs when the mortgage loan payment for any period is less than the interest charged over that period so that the outstanding balance of the mortgage loan increases.
The Inherent Risks of Negative Amortization Mortgage Loans
Negative amortization means that even when a homeowner pays the mortgage loan, the amount owed still increases because they are not paying enough to cover the interest.
Banks can offer homeowners the option of making minimum payments that don’t cover the interest owed. The unpaid interest will be added to the amount borrowed, meaning the amount owed will increase over time.
Eventually, homeowners will need to begin making payments to cover principal and interest. These payments will be higher. Negative amortization loans can be risky because homeowners can end up owing more on their mortgages than their homes are worth, which can result in difficulties down the line if the owner wishes to sell their home since they will owe more than the house is worth. Negative amortization can put homeowners at risk of foreclosure if they are unable to make mortgage payments.
Homeowners often opt negative amortization at the start of a loan term because it reduces their initial monthly payments and it also diminishes the instability associated with a sudden an increase in the interest for an adjustable rate mortgage.
Experts warn homeowners against negative amortization when it is used as a predatory loan practice.
The American Bar Association says, “In the context of home mortgage loans, predatory lending practices strip the equity from a home. In essence, practices which at first blush appear to enable home buying ultimately destroy the possibility of authentic ownership.”
New mortgage rules set forth by the Consumer Financial Protection Bureau in 2015 are intended to protect homeowners from predatory loan practices.
“When the lender is reviewing a borrower’s application, the lender is now required to determine that the borrow currently has available assets and income that will allow him to make the required loan payment throughout the life of the loan. In order for the lender to determine the borrower’s ability to repay, the lender must look at the borrower’s current debt-to-income ratio. This determination requires a lender to review all of the debt the borrower has, and the terms and conditions for the repayment of that debt,” says Florida real estate attorney Daniel P.J. O’Connor.