Negative Amortization and Different Types of Mortgages
Negative amortization refers to an increase in the principal when the monthly payment does not cover the interest. The borrower ends up owing more because the accrued interest is capitalized or added to the principal. For instance, the interest payment is $550, and the borrower only pays $350. The remaining $200 will be added to the loan’s principal. As a result of this, the remaining balance increases, and the borrower owes the financial institution more.
Amortization refers to the reduction of the loan or mortgage balance over time. In the case of negative amortization, the loan is unamortized. The main reason why people take out such loans is to lower their periodic or monthly payments. Some borrowers use the funds to finance the purchase of a home they cannot afford. It is usually done by people who expect that their income will increase in the future. Negative amortization loans are often used for speculative purposes, especially if property prices are expected to increase. This is a risky strategy, and loans add leverage and risk.
Negative Amortization Types
The graduated payment variety is a type of fixed-rate loan. The monthly payments start low and then increase with time. The initial payments go toward the principal because the borrower doesn’t make interest payments. This type of mortgage is an option for young homebuyers who expect a gradual increase in their income level. People with moderate and low incomes usually resort to graduated payment mortgages. Anyone who meets the payment amount, cash investment, and credit requirement can apply for a loan. The payment option ARM is another type of negative amortization mortgage which allows people to choose from different payment options. Borrowers can opt for a minimum, interest only, 15-, 40-, or 30- year fully amortizing payment. Again, the accruing interest is more than the monthly payment and is added to the loan’s outstanding balance. The new balance is used to calculate the next payment. Taking out an option ARM loan involves some risk. The property may lose value or it may not appreciate. The rate of interest may increase in the long run. Both may materialize in the worse-case scenario.
When the home’s value is less than the outstanding balance, this is known as being upside down or under water. The monthly payment increases substantially and if interest rates go up sharply, refinancing is not an option. The biggest problem of such loans is that homeowners who want to sell their home may be unable to. The sales price may not cover the outstanding balance of the mortgage. This means that the borrower will still owe money and won’t gain any profit, resulting in serious financial problems. It may force the borrower to declare bankruptcy and his credit score will be affected.
Some people benefit from negative amortization mortgages. This is the case with seasoned investors who have solid finances and good knowledge of different property types. They can refinance or sell the property within a certain timeframe.
Negative amortization loans are also for borrowers with seasonal income and those who don’t have fixed incomes. Some professionals and companies have lower incomes in some periods and higher in others. Besides, less documentation is required to apply for financing.
While there are advantages, some people take out a loan and put little or nothing down. This is one of the reasons for the subprime lending crisis. Both reputable financial institutions and predatory lenders were responsible for the real estate slowdown.
Reverse Mortgage to Access Your Equity and Grow Your Wealth
Reverse mortgage loans are based on your home equity, and payments are deferred in case the property is sold or the homeowner passes away. The loan amount varies based on factors such as property location and value, interest rates, and the customer’s age. The amount can be distributed as a credit...
Second Mortgages for Home Improvement and Major Purchases
A second mortgage is a type of secured financing, which is considered subordinate. This means that there is another loan against the same real estate property. Payments are made only after the first mortgage has been paid off. Because financial institutions take more risk, they offer a higher...
Benefits, Drawbacks, and Terms of Fixed-Rate Mortgages
A fixed-rate mortgage is a type of loan that comes with a fixed instead of floating interest rate. The rate of interest remains fixed over the term of the loan. The period can vary from 10 to 35 and even 50 years. Payments go toward interest charges first and then toward the principal amount....