Negative Amortization Checklist

When negative amortization occurs, your monthly payments do not cover the interest owed for the month, and the difference is added to your principal. Some adjustable rate mortgages (ARMs) have terms that allow negative amortization to occur.

You will want to consider negative amortization and its effects before making a commitment to one of these mortgages. The following is a list of questions to think about when making a decision relating to negative amortization.

1. How will the loan’s initial payment be calculated? An ARM that allows for negative amortization will not necessarily use only the initial interest rate to calculate the initial monthly payment amount. The initial payment may be calculated using the initial interest rate only, but may also use the initial rate but include only interest, or use another interest rate entirely to calculate initial payments.
2. Is the regular payment adjustment period the same as the initial payment adjustment period? Often it is, but this is not always the case.
3. What is the payment adjustment cap? If the loan allows negative amortization, there is usually a cap, and it is often somewhere around seven or seven and a half percent.
4. Is there a negative amortization cap? What is the negative amortization limit? Many ARMs that allow negative amortization limit either the total amount of negative amortization or the length of time negative amortization can go on. The upper limit is expressed as the total loan amount after negative amortization has occurred, and is often near 110 or 115 percent of the loan’s original amount.
5. Is there a payment recast period? If so, what is it? There is often a time limit, called a payment recast period, after which the loan’s monthly payments will be adjusted to be fully amortizing. The new payments will be based on the current balance of the loan, the current interest rate, and the amount of time remaining on the loan’s term.

These questions will provide you with a good start in understanding a loan that allows for negative amortization.