When mortgage payments on a loan do not cover the full amount of interest that is due, any unpaid interest is then added to the principal balance of the loan. Under a standard amortization, the principal balance decreases with each payment over until the loan is completely paid in full.Negative Amortized loans are often a good choice for investors. The monthly payment is lower than regular loans, which means more cash flow for other investments. An investor often knows exactly how long he plans on keeping a home and how much profit he stands to make, so the deferred interest is accounted for at the beginning of the project.
The most common home mortgage loan that can incur negative amortization is the Pay Option ARM loan. This loan is one which provides the borrowers with multiple payment options on their monthly mortgage statement each month. The lowest payment option each month can possibly have negative amortization occur. Negative amortization is when the payment made does not have enough to cover the interest on the loan and your loan balance actually increases instead of goes down.
In some cases an Option ARM, or negative amortization loan, is also a good option for the self employed, seasonal and commissioned employees. This gives you the flexibility to make minimum payments in a slow part of the year, and make larger than normal payments during busy months. This does however require discipline. Making the minimum payment every month will cause your mortgage balance to increase, rather than decrease over the long term.
The penalty for paying off an Option ARM can often be six months worth of interest.
While this type of mortgage can make sense in an rapidly appreciating market (when the increased property value will offset any additions to the principal), you still need to be careful and make sure you understand what you are getting.
If you are considering a "Neg Am" mortgage, make sure you check on how long the prepayment penalty is. In a lot of cases, if you sell or refinance the home within the first three years, you will be charged a substantial penalty.
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