The Real Estate Encyclopedia
What Is Negative Amortization And When Does It Occur?
Category - Home Ownership Questions - General Home Ownership FAQ's

Negative amortization occurs when the outstanding principal balance of a loan goes up rather than down because the monthly payments made by the borrower do not cover the full amount of interest due. The outstanding amount of interest owed is added to the loan's principal, which ultimately causes the borrower to owe more money. 


Negative amortization allows a borrower to make lower monthly payments for a certain period upfront but results in higher payment at a certain point during the life of the loan.  For example, if the periodic interest payment on a loan is $700 and a $600 payment is contractually agreed upon, $100 is added to the principal balance of the loan.


Adjustable-rate mortgages (ARM) with a negative amortization feature are known as payment option ARMs. Fixed-rate mortgages with this feature are known as graduated payment mortgages.


While these mortgages allow borrowers to make low monthly payments for a short time, the monthly payments will increase substantially at some point over the term of the mortgage. The date or dates when payments increase on a fixed-rate graduated-payment mortgage are contractually set. Payment option ARMs also have scheduled payment increases, but they are also linked to interest rate hikes and, therefore, carry a great deal of payment shock risk. 

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