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| Loan Process Guide |
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| Negative Amortization |
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Negative amortization loans are some of the most misunderstood loans available in the market place. The negative stigma (no pun intended) comes from a lack of education to the consumer by mortgage professionals. The only way you can get into trouble with a negatively amortized loan is if you truly don't understand how it works, or if you lack the financial discipline to make sure you are not allowing yourself to fall into a compromising position.
In a regularly amortized mortgage payment, part of the payment goes toward a portion of the principal and part goes toward interest payment. |
In a loan that involves the potential for negative amortization, you have several payment options each month. You can make a low introductory rate payment, an interest-only payment, or a fully amortized payment. This type of loan works very well for borrowers with a seasonal income, or income that fluctuates. Certified Public Accountants, investment advisors, and sales people who work on a commission basis often go with this type of a loan because it allows them to have greater control over their cash flow on a month-to-month basis.
Once again, each and every month you must choose between three payment options. Let's understand how a negatively amortized adjustable rate mortgage works. All adjustable rate mortgages require the lender to add a fixed component (which is known as the margin) to the varying portion of the adjustable known as the index (T-Bill, Libor, 11th District Cost of Funds, etc.). In an adjustable rate mortgage, the margin + the index = your interest rate.
If your fixed margin is 3 and at the time of an adjustment the varying index of a treasury bill is 4, then your interest rate is 7%. Negatively amortized loans typically adjust on a monthly basis, which means that every single month the lender takes the fixed margin and adds it to the varying index to derive your current interest rate. One of the protection vehicles of an adjustable rate mortgage is called CAPS.
CAPS limit the amount that your payment can go up in any monthly period of time. In a negatively amortized adjustable it is common to have a 7.5% annual increase CAP.
For example: If your mortgage payment in the calendar year of 2003 was $1,000 per month, the most that your mortgage could be in the calendar year of 2004 is $1,075 dollars per month.
This is because the annual payment increase CAP of 7.5% would kick in and limit an obligated payment to the lender to a maximum of 7.5% increase over the previous year's payment. However, during each of those months the lender would still add the fixed margin to the varying index to derive what the true interest rate is and calculate the mortgage payment associated with that true interest rate. If in fact the payment in this example came out to $1,100 a month, you would still only be obligated to pay $1,075. However the $25 difference would be tacked on to your principal balance that you owe, therefore accruing interest against your principal and increasing the balance that you owe on your loan to more than you originally borrowed. Hence the term "negative amortization" comes into play. |
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