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What Is Negative Amortization For An Adjustable Rate Mortgage?

By Jim Micheals

Find out when an adjustable rate mortgage begins a new cycle of negative amortization and how loan balances may change despite payment cap clauses.

Borrowers should understand the difference between a traditional fixed rate home loan and an adjustable rate mortgage to make an informed decision. Both types of loans include unique benefits and risks. A negative amortization clause deserves careful consideration before accepting a new loan.

Understanding Adjustable Rate Mortgages

An adjustable rate mortgage allows interest charges to fluctuate. Financial indexes determine how much interest borrowers must pay. The most common financial index used to determine an interest rate is the Monthly Treasury Average. As a result, interest charges may change frequently. To add a degree of predictability, lenders may offer payment caps to restrict the amount a monthly payment may change over time. Fixed rate home loans do not have an adjustable feature. Payments due on a fixed rate loan remain the same each month over the life of the loan.

Negative Amortization

An adjustable rate mortgage may include a variety of different payment caps. Most payment caps limit unexpected payment increases by a percentage amount. Upon first impression, payment caps are desirable. Nevertheless, a payment cap does not reduce the amount of interest owed but merely delays payment to a future date.

Lenders add unpaid interest to the principal balance owed. When interest charges increase the amount of principal owed when making all regularly scheduled payments on time, the loan is in a state of negative amortization. Over a prolonged period, negative amortization may increase both the balance of a loan and monthly payments dramatically.

Negative amortization rarely poses a significant threat for homeowners so long as financial markets remain stable. When large market upswings occur, homeowners with adjustable rate mortgages should expect regular increases in monthly home payments.

Related posts:

1. What Is a Pay Option Negative Amortization Adjustable Rate Mortgage?
2. When Should I Consider An Adjustable Rate Mortgage?
3. How Soon Can I Refinance An Adjustable Rate Mortgage?
4. What Are The Risks Of An Adjustable Rate Mortgage?
5. What is an Adjustable or Fixed rate Mortgage?