What is Negative Amortization?

When payments are made on a loan that is less than the accrued interest, this is called negative amortization. The difference that results is then added to the loan balance.

Purpose

The primary purpose that one would take such a loan in the beginning, was to reduce the monthly payment overall in both fixed rate loans and ARMs. Secondary to that was to reduce what has been termed as payment shock - which generally occurs with an adjustable rate mortgage when the rate increases.

The True Cost of Negative Amortization

The negative amortization loans are great in the beginning when the payments are lower. These loans are generally used by borrowers when they believe that future income will be more than it is at present. You do, however, incur a certain amount of risk with such loans because there is no guarantee that you income will indeed increase to the necessary level in the future.

Another use for these loans has been by housing investors, who will opt for a negative amortization loan believing that the house's value will increase significantly in the near term and they will be able to sell at a large profit.