Negative Amortization and Property Values

The concept of negative amortization can be a tricky one on its own for many borrowers. Combine this with a discussion of property values, and many people might be attempted to quit while they are ahead. However, the relation between these concepts is important and not as confusing as it might seem at first glance.

Negative amortization is a process that allows borrowers to pay less each month than the interest owed for the month. The difference is added to the loan’s balance, resulting in a loan amount higher than at the beginning of the mortgage’s term. The amount is controlled by a negative amortization cap. This cap doesn’t necessarily protect the borrower, since when the cap is reached monthly payments generally are exposed to a very sharp increase in costs.

However, the cap does keep the loan balance down. In a market where real estate values are increasing, these caps will likely serve to keep the amount you owe equal to or under the value of your home.

In this type of market, the bad effects of negative amortization are somewhat offset by the fact that home equity is still increasing due to rising property values. For example, if your $100,000 loan rises to $110,000, your property may still now be worth $130,000 with appreciation.

This is the good news. The bad news is that the market does not always work this way. Real estate values can also decrease, sometimes quickly. This is a worst case scenario for many borrowers who have a mortgage that allows negative amortization.

While property values can fall to the point where you owe more than your home is worth with other loans, the possibility is higher with mortgages that allow negative amortization. These borrowers could sell their house for market price and still owe money on their loans.

In the end, the real estate market in your area and the possibility of rising or falling property values is just another factor borrowers should think of when considering a mortgage with negative amortization.