What is Negative Amortization?

Negative Amortization means that the loan balance can actually increase.

If you make the minimum payment the difference between the minimum payment and a principal and interest payment will be added back onto the balance of the mortgage.

If the interest only payment is greater than the minimum payment in any given month, you have the option to pay either amount. If you choose to pay only the minimum payment, any additional interest which is due is deferred at that time.

When the loan is "re-cast", usually after five years, any deferred interest is then added to the principal balance resulting in Negative Amortization. The deferred interest can be paid at any time prior to the re-casting of the loan and becomes tax deductible once it has been paid.

Negative amortization can be a very bad thing if it continues to happen every single month. You will not build equity in your home, but you will actually lose equity in your home. Negative amortization type loans can be a good option for borrowers who have very unstable incomes where the ability to make an ultra low payment is available. This way when they are having a low income month they can simply make the lowest payment possible and when they have better income producing months they can make a much higher payment. Negative amortization loans are not for everyone.

The maximum amount of negative amortization that can occur is limited. Depending in which state your property is located, the limit is between 110% and 125% of the original principal balance.

Option ARMs (also known as pay option or pick-a-payment ARMs) function differently than other types of loan products. In general, the minimum payment will only change once a year. The interest only payment is calculated monthly.

At the end of every year that you're on a Negative Amortization loan. You will receive a bill, with the accumulation of the deferred interest accrued through out that year. You will have two options, either pay it lump sum or add it to the loan amount (Principal loan is getting bigger).