by Dell Claiborne
What is negative amortization? Do you recommend it? If I want to revert to a regular loan, can I?
Great question! In the current market, with a large inventory of homes and interest rates still historically low, this is a question that really needs to be addressed. You’re no doubt hearing that now is the best time to buy and also hearing about different loan programs and options. Let me first explain how amortization works so that you can better understand negative amortization. Traditionally, when a loan amortizes, the borrower’s payment is a combination of both interest and principal. As payments are made over time, the total amount of the loan decreases until the loan is paid off. A negative amortization loan is a loan where your monthly payments cover less than the monthly interest owed and none of the principal. The difference is then applied to the total loan amount. The result is that your total loan amount actually increases rather than decreases like with a traditional loan. So every time you make a payment, you end up owing the bank more. The positive aspect of negative amortization is that these loans have lower monthly payments. That is the allure of these loans: purchasers could buy a home they otherwise couldn’t afford. This can be a great situation for a borrower who is expecting an income increase down the road and can then refinance into a traditional loan. Many times negative amortization loans will be set for only a short amount of time, not the entire length of the loan. So borrowers can plan ahead and make sure they are in a position to refinance into a more conventional loan.
One thing to inquire about before choosing to refinance is whether your loan includes a prepayment penalty. Each loan is different, so make sure to contact a professional if you have any questions. You asked if I recommend negative amortization loans and I would have to answer with an emphatic – maybe. It really depends on the situation. I think that real estate investors can benefit from the low payments and leverage the saved cash into more investments and be quite successful. I also think that speculating in real estate can be risky. Investors should understand that negative amortized loans add another level of risk. For the individual homeowner, I believe that negative amortized loans can allow one to get into a home now that may be a little out of their price range. The individual homeowner must also understand that a negative amortized loan is only one way to get into a new home and that a more traditional amortized loan is the way to stay in your home long term.
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