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A negative amortization or Neg Am loan is a type of loan that is usually used in the purchase of real estate and may be helpful to first time buyers who can’t afford huge upfront mortgage payments. In a Neg Am loan, initial payments do not even cover the full cost of interest accrued on the loan. The remaining unpaid interest is added to the money owed on the house, so the loan increases in size. While this may be attractive to buyers at first, Neg Am loans only allow below interest rate payments for a short period of time, and eventually, payments must increase to cover the full cost of interest, which is now higher than it would have been in the onset since the total amount owed is higher.
When a real estate market is hot or booming, some people choose to get a Neg Am loan since there is a good likelihood that the value of their house will quickly increase, and they can thus refinance for lower payments similar to their initial house payments. There is, of course, no guarantee that this is likely to occur. A real estate market can suddenly grow cold and housing prices can become stagnant, or even drop. This can further complicate matters for the person who has the Neg Am loan. If the mortgage payments can’t be met, the person may have to sell the house at a loss, since he/she is not only responsible for the initial loan, but also unpaid interest that has accrued. A person with little equity in a home might end up with no house and additional money owed.
What a person can expect with a Neg Am loan is that payments will increase within a specified period of time. This can occur after a year or two, usually at the most within five years, loans payments must at least cover interest. If you have a Neg Am loan and can make payments to the principal or to cover extra interest prior to this being required, it is highly recommended you do so.
Interest on Neg Am loans is almost always given at an adjustable rate. In a market with rising interest rates, debt accrued through unpaid interest can quickly skyrocket. Where interest rates are dropping, again not always something you can depend upon, less total debt may be owed.
Payments on this type of loan don’t necessarily go up dramatically. Some Neg Am loans are graduated — meaning over time, your payments will gradually increase until you are paying at least the interest, and often some of the principal too. Another type of loan similar to the Neg Am loan is the interest only loan. For a period of time, mortgage payments may only cover the interest owed. This means the loan size doesn’t increase, but it doesn’t decrease either. Unless the property value increases, an interest only loan merely marks time and does not give you more equity in a home. These are also subject to increases in payments after a specified period of time, so that not only interest but part of the principal is being paid.