There are so many types of mortgages available for people that it is often difficult to understand which one to choose. One type of mortgage that can be confusing is a negative amortization mortgage. Amortization is the process of paying off the interest and principal of a loan slowly overtime in scheduled monthly payments. Every time you make a payment you are paying that months full amount of interest and some portion of the principal balance. Negative amortization means that the monthly amount you pay is not enough to cover the cost of interest on the loan, and therefore whatever is left unpaid is added onto the principal balance. This means that the balance of the loan is increasing instead of decreasing.
Now you may be even more confused, wondering why someone would want to take out a loan where the principal balance continually increases. Even more confusing is the question, why would a lender give a loan where the balance continued to increase and the borrower wasnt even paying a large enough monthly payment to cover the interest on the loan?
Lenders and borrowers will sometimes knowingly take out a loan with negative amortization, and sometimes it happens as a result of market rate interest trends. Some reasons that borrowers and lenders may end up with a negative amortization loan are:
Negative amortization loans have appeal depending on your specific future needs and current circumstances. You may consider a negative amortization loan, like a Graduated Payment Mortgage loan, if you are not planning to live in a home long and do not want to pay higher costs and interest rates associated with a fixed rate loan. You may also want to get a negative amortization loan if the real estate market in the area you are buying the home is booming as the value of the home will increase faster than the principal balance owed on the loan. Always consider all of your options and consult with your mortgage lender about your home loan needs before choosing a mortgage loan type so that you can get the one that suits your needs the best.