A negative amortization mortgage loan may not ring a bell for many homebuyers. However, this type of financing is available to those who are looking for an alternative home financing method other than a conventional or a federally-backed loan.
It is otherwise known as neg am loan. It falls under the Non-qualified Mortgage category. Mortgages that fall under Non-QMs don’t meet the Consumer Financial Protection Bureau requirements for them to be considered qualified loans. However, this kind of financing is originated due to the need.
Qualified Mortgages are restricted by regulations and laws which may hinder some financially-able buyers to get a loan because they lack a few requirements. Thus, non-QMs are originated to cater to these people.
How does a Negative Amortization Mortgage Work?
In a neg am loan, a borrower isn’t required to pay the mortgage’s monthly interest. Within a specified time period, the homeowner will only be required to make minimum payments set by the lender.
In a ‘conventional’ amortization scheme, each time a homeowner makes monthly payments, this money will be divided. Part of it covers the monthly interest and a part pays a portion of the mortgage principal.
Therefore, amortization is defined as the process of paying off borrowed money (in this case, a mortgage) on scheduled payments over a specified payment term.
Now, neg am mortgages work differently. Remember that you are not required to pay the monthly interest on this loan. If you choose not to, the interest will be rolled over to the succeeding month. If you chose to pay a part of the monthly interest, the remaining balance will be carried over.
The unpaid interest will be added back to the existing loan balance. The interest rate will then apply toward the new loan balance on the following month.
This is why a neg am mortgage is also known as graduated payment or deferred interest loan.
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The Pros and Cons of a Neg Am Mortgage
What are the advantages?
This loan product is excellent for homebuyers who are also planning on investing.
The initial monthly mortgage payments are lower which allow the borrower to use the remaining money for other important things, such as an investment.
If the investment pays much higher than the mortgage loan’s interest rate, this can cover the increasing principal balance. You also may have more left as savings.
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What are the potential pitfalls?
A neg am mortgage borrower is at a high risk if the loan is mismanaged.
Making the required minimum payment each month may not significantly reduce the principal. Once the negative amortization period is over, a homeowner may end up with more debt than what they originally owed.
If this happens, the borrower may not be able to afford the mortgage anymore, risking the property into foreclosure.
Conclusion
A negative amortization mortgage loan isn’t for everyone. If you can afford and are qualified for a conventional loan, consider exploring that opportunity.
However, negative amortization mortgage loans have provided certain people a chance to purchase their own homes. If you think that this loan product fits your home financing needs, do not hesitate to talk to a trusted loan professional and learn more about it. An expert’s advice can help you make better decisions.