Negative Amortization and Fixed Rate Mortgages

Negative amortization is typically associated with adjustable rate mortgages (ARMs) that feature payment caps or initial monthly payments that are too low to cover the amount of interest owed each month. However, there are some fixed rate mortgages that allow for negative amortization.

Graduated payment mortgages (GPMs) begin with small monthly payments that increase over a fixed period of time. The initial payments are smaller than required to pay the monthly interest, but eventually increase to a fully amortizing level.

Generally speaking, a lower initial payment and smaller payment increases lead to a higher final payment and an increased amount of negative amortization. However, depending on the initial payments and payment increase plan, GPMs can actually feature lower final payments than interest-only loans that do not have negative amortization.

Negative amortization associated with GPMs differs slightly from the negative amortization found with ARMs. While ARMs feature negative amortization caps to limit the amount of negative amortization, GPMs include a fixed amount of negative amortization, making caps unnecessary. Because of their fixed nature, the precise amount of negative amortization can be calculated in advance for GPMs.

While GPMs are a good choice for those who can reasonably anticipate that their income will rise as the payments on the mortgage do, they have a higher rate of default than standard fixed rate mortgages without negative amortization.

This is probably because, even though the higher future payments are known in advance, many borrowers who select GPMs do so only because they can only afford the lower payments, or because the lower payments are necessary to get a loan. GPMs do carry consequences for these borrowers, and they should examine them closely before choosing this option.