0

I want to better understand the term "negative amortization".

For example, in the Graduated Payment Mortgage (GPM), people often say it usually has negative amortization as the loan balance increases initially.

So, the (positive) amortization simply means the loan balance decreases over time?

negative amorization <-> loan balance increases over time

(positive) amortization <-> loan balance decreases over time

Is this correct?

Improve this question

1 Answer 1

Reset to default
3

A regular mortgage has its balance decrease over time (you could say it 'amortizes' over time), because the total monthly payments are higher than the monthly interest charge.

Take a 100k mortgage with 3% interest, with a 30 year term. Monthly interest will be about 100k * .03 / 12 = $250, while the monthly payment will be about $420. Therefore every month, $170 is used to pay down the remaining principal balance. In the second month, that remaining principal balance will accrue a tiiiiny bit less interest, and you will have the same $420 payment, so a liiiiittle bit more will be used to pay down principal.

In a GPM, the payment in your first month might only be $200, even though $250 in interest was charged. So your payment won't even cover the interest for that month, and next month you will have a larger principal balance remaining. You could call this negative amortization, for the period until the monthly loan payment is higher than the monthly interest charge.

Improve this answer
6
  • 1
    This isn't even an interest-only loan. What banks even approves this?
    – RonJohn
    Oct 2, 2019 at 13:37
  • 1
    @RonJohn Not only that - I shudder to think what people might be tricked into doing this without fully understanding it...
    – Grade 'Eh' Bacon
    Oct 2, 2019 at 13:51
  • What, though, does the bank get out of it except losing money and much higher likelihood of foreclosure? It's losing all around for the bank!!
    – RonJohn
    Oct 2, 2019 at 14:01
  • 1
    @RonJohn I'm not sure if this product even still exists; much like NINJA loans [No Income, No Job, no Assets], I would hope these are a thing of the past ever since the sub-prime mortgage crisis. Remember that the fundemental buildup of the crisis was that banks initiating mortgages would sell those mortgages in bundles to investors, and the ratings agencies improperly continued to rate them as A+ assets without understanding that loans close to default might be buried within the bundles. So the banks that set up the mortgages didn't care, and the ones that should have cared didn't know.
    – Grade 'Eh' Bacon
    Oct 2, 2019 at 14:57
  • 2
    @RonJohn The key word is "graduated". The monthly payment goes up later. This was a tactic during the subprime bubble to entice borrowers with mortgages that look more manageable at first, and to build up a history of borrowers making the initial smaller payments so it would be easier to resell them.
    – Acccumulation
    Oct 2, 2019 at 16:11

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .