Mortgage Dictionary -> Negative Amortization
It seems hard to believe, but in some cases, the monthly payment on a bill may be such that it does not even take care of the interest that accrues monthly. If you've ever heard anything about negative amortization, then you probably understand this concept quite well. However, whether you do or you don't understand negative amortization, you'll want to read on.
What is Negative Amortization
Negative amortization is actually a rather rare occurrence in the repayment of loans, but it occurs nonetheless. When a loan payment for a particular period is less than the interest that has accrued during this same period, the balance grows rather than decreases. Anytime a balance grows after a payment rather than decreases, this is considered to be negative amortization.
Two Reasons Why Negative Amortization Occurs
1. Low Initial Payments. Particularly in the case of Adjusted Rate Mortgages, lenders will offer payments that sometimes do not even cover interest from month to month. This is done so as to attract borrowers who cannot afford minimum payments at first, yet still want a mortgage.
2. Mistake on Payments. In very rare cases, the lender screws up something in the contract and tells you to send in a payment that does not cover even the interest. Usually, this type of negative amortization is caught rather quickly and is corrected, but if neither party notices, it can go on.
Why is Negative Amortization a Bad Thing?
There are actually many reasons why negative amortization is a bad thing. The first is that it keeps you from repaying the loan and can add many years to the life of a loan. If you're hoping, for instance, to pay a mortgage off in 30 years, you might not like how negative amortization extends this to 35 years or more, depending on it.
The second is that it results in a higher amount of interest charges. No one likes paying back not only the loan money itself, but extra money to the lender, so most try to avoid extra interest charges at all costs. Negative amortization makes it difficult to avoid these interest charges.