What is Negative Amortization?
The term "negative amortization" refers to the potential for your loan amount to increase over time - in other words, you might have reverse or "negative" amortization. These loan programs allow you to pay less that the full amount of the interest due on your mortgage. If you pay less than the full amount of interest due, the difference is added to your principle balance. A typical negative amortization loan has the potential of growing to 125% of its original amount.
It Goes By Many Names
Negative amortization mortgages are sold as "Option ARMS", "Pay Option ARMS", "Pick-a-Pay" programs, and a variety of other names. The characteristic they share in common is a low payment rate, usually between 1% and 1.95%. This rate is not the true note rate; it is the rate that your payment is based on. The true note rate is a market rate, or "fully indexed rate", and may be 5% or more above the payment rate.
A Nationwide Phenomenon
I’m a Florida mortgage broker and also hold mortgage broker licenses in Georgia, Massachusetts, and Virginia. Florida mortgage customers have increasingly turned to these mortgages as real estate values have increased over recent years. This phenomenon, of course, is not limited to Florida. As home values nationwide have increased, borrowers have struggled to find ways to afford homes that once cost half as much.
Look at Your Real Cost
And please don’t assume that you are saving money. Without a doubt you are going to enjoy your tiny payment (as long as it lasts), but make sure that you take a good look at the fully indexed rate. This is your real cost. Compare the fully indexed rate with the rate on a good old fashioned 30 year fixed rate mortgage. You might find that the real cost of your super low payment negative amortization loan is quite a bit higher than the fixed rate option that is available.
It’s Not a Fixed Rate Mortgage
We often get calls from customers that have been approached by other mortgage brokers offering these products. And it never ceases to amaze me how many of these callers believe that these are fixed rate mortgages. At one percent! Occasionally the caller will be furious at me for dashing their hopes. If you are considering a negative amortization mortgage please make sure that you understand what you are getting. As a Florida mortgage company we deal with a fair percentage of retired people for whom these loans are simply not appropriate.
The HELOC Problem
If you have a negative amortization mortgage you may not be able to get a second mortgage or a home equity line (HELOC). What’s up with this? Second mortgage and HELOC lenders base their loans on the amount of equity that you have in your property. Since your negative amortization mortgage has the potential to increase, the amount of equity that you will have in the future is uncertain. You may find that your best bet for a second mortgage or HELOC is with the same lender that gave you the negative amortization mortgage.
A Lower Payment is Really Nice
There are some attractive characteristics of negative amortization mortgages. Well, one anyway. You get to make a lower payment. A lower payment can mean many things. It can make that house that you want to buy affordable. And it can free up your cash flow for other things. If you have a pile of high rate credit card debt you might make a very solid case that you are better off making the smaller payment on your mortgage and channeling your savings towards paying down your credit cards.
Keep an Eye on Your Monthly Bill
You would be well advised to keep an eye on your monthly bill which will tell you how much negative amortization is accruing. Make sure that you don’t drift into a state of denial. When you are ready to sell your home your proceeds will be reduced by the fattened balance of your mortgage. Florida mortgage customers, like those in other states have seen property values soften in the last year. Be aware that your equity could be effected by the market as well.
When the Party’s Over
Normally your minimum payment will increase a small amount each year for the first five years. At the end of the five years you loan will be recast. This means that your loan will be amortized over the remaining term of the loan – normally 25 years. Make sure that you are prepared for the potential payment change. It doesn’t hurt to ask your mortgage broker to calculate the worse case scenario for you. It’s best if you know the potential.
