Negative Amortization

Negative amortization exists if a borrower makes a payment that is less than the interest that is owed, and the difference is added to the balance of the loan. If you take out a payment option adjustable rate mortgage, it may have a negative amortization feature. Similarly, fixed rate mortgages that have negative amortization are called graduated payment mortgages. There are many different options associated with mortgages, and it may be helpful to retain legal counsel with respect to negative amortization and other aspects of a property transaction. At Pulgini & Norton, our Boston real estate attorneys provide experienced counsel to people buying and selling their homes.

An amortization is a reduction in a loan balance owed to a mortgage lender. In the usual course of things, a mortgage payment has two components, interest for the month and amortization of the principal. When, for example, the payment maintained over the term of 30 years pays off only the balance with no change in the interest rate, it is fully amortizing. If you paid more than the amount that you were supposed to pay, you would pay off the loan before the 30 years. However, if you paid less than the set amount, you would still have a balance at the end of the 30-year term. Amortization might still happen, but it would be a smaller amortization and not enough to get the balance to zero by the end of the term.

When there is a shortfall in the interest that you pay, it is added to the loan balance, and by the end of the first month, it is as if the lender has made an additional loan of the amount of the shortfall. If the payment does not cover your interest, the increase in the loan balance is considered negative amortization.

In other words, negative amortization involves a lender increasing the principal balance of a loan because the borrower has made payments that do not cover the interest that is owed. This practice results in a borrower owing more money. For example, suppose that the periodic interest payment is $400, and you can make a $300 payment, so you do. In that case, the $100 is tacked onto the principal loan balance.

When negative amortization is a feature of a mortgage, a borrower is allowed to make low monthly payments for a period of time, but eventually the monthly payments increase dramatically over the mortgage term. You will know when the payments are going to increase on a fixed rate graduated payment mortgage. Similarly, payment option adjustable rate mortgages come with scheduled payment increases, but they may also be triggered to recast before the scheduled increase. There is a significant risk of being surprised by your payment.

What is the purpose of negative amortization? It is used to reduce a mortgage payment at the start of a loan term. It also reduces the potential for shock related to a very large increase in payment associated with an increase in the interest for an adjustable rate mortgage.

The problematic aspect of a negative amortization feature is that your payment will increase later in the life of the mortgage. When there is a lot of negative amortization late in the term, there is a larger increase in payment that is needed late in the loan to fully amortize it.

For many people, the most expensive transaction of their lives is buying their home. There are many hidden costs involved in buying a home, and buyers may easily become overwhelmed by all of the aspects to consider when determining whether a particular home is a good deal for them, and whether a particular mortgage will work, given their career and income expectations. At Pulgini & Norton, our experienced Boston attorneys can advise you on whether it is a sound decision to get a mortgage that features negative amortization or whether you might have better options. Our firm also handles real estate transactions in other Massachusetts communities, such as Weymouth, Newton, and Braintree. For a consultation with a mortgage lawyer, contact us online or at 781-843-2200.