subject: The Effects of Negative Amortization [print this page] The Effects of Negative Amortization The Effects of Negative Amortization
Are you planning to buy a home? If you do, then you have to be very careful in taking a negative amortization offer. Here are the basics of negative amortization that will help you to understand this option.
When you take out a home loan, you are expected to repay the full amount to the lender. Loan repayments can vary from lender to lender. But generally, you have to make monthly payments over a certain period as defined in the terms of the loan.
This system is called repayment amortization. However, there are some repayment tables that could be designed to become more problematic over time.
An Overview of Negative Amortization
It is a fact that mortgage lenders are competing against each other in attracting new borrowers. This is the reason why some lenders will offer unique and unconventional mortgage packages that will entice you to get a home which is way beyond your means.
One of the most common techniques employed by lenders is known as graduated payment schemes. This type of repayment method requires you to pay far smaller amounts than the interest owed on the loan. The excess unpaid interest will accumulate and will be converted into principal.
This is also known as negative amortization and is a very risky process because it relies heavily on an uncertain bet. By choosing negative amortization, you are actually hoping that the equity will increase faster than the accumulated interest. Unfortunately, when the equity failed to increase, you will be making payments on a home with no equity. You will find yourself deeper in debt once the amount owed on the home surpasses the equity value. Your home therefore will become a pure debt instead of an investment.
What Happens When Things Go Wrong
Mortgage lenders will never allow the principal to accumulate forever. To hedge against this risk, lenders will apply a debt cap on the loan. Once the cap has been reached, the original loan will be converted to another type of loan. You will now be required to start paying off the balance or the loan will become due.
To illustrate this situation, your mortgage contract may indicate that once the total debt exceeds 115 percent of the value of the home, the loan will automatically convert or may become due. In both instances, you will certainly face a very huge problem. First of all, you will be required to make regular payments that you can not afford. In worst scenarios, you will have to pay-off the entire loan. This means you need to come up with a huge sum of money in order not to lose your home.
For most homeowners who have pursued negative amortization, loan conversion could eventually lead to default. This is certainly a big problem that you will have to solve immediately.
At first glance, negative amortization is very attractive. But you have to understand that this repayment scheme is full of risk. Before you take out a loan with negative amortization, you have study its impact on your finances.
