Mortgage Financing - Negative Amortization

Negative Amortization

Most people have no idea what you are talking about if mention negative amortization to them. Hopefully this will make it a little easier to understand. Ordinarily, the mortgage payment you make to the lender has two parts: interest due the lender for the month, and amortization of principal.

To put it simply, amortization means reduction in the loan balance or, the amount you still owe the lender. For example, the monthly mortgage payment on a level payment 30-year fixed-rate loan of $100,000 at 6% is $600. In the first month, the interest due the lender is $500, which leaves $100 for amortization. The balance at the end of month one would be $99,900.

Because a payment of $600 a month maintained over 30 years would just pay off the balance, assuming no change in the interest rate, it is said to be the fully amortizing payment. A payment less than $600 would leave a balance at the end of 30 years. A payment greater than $600 would pay off the loan before 30 years.

For example, lets say that you made a payment of only $550 per month. Then only $50 would be available to reduce the balance. Amortization would still occur, but it would be smaller and not sufficient to reduce the balance to zero over the term of the loan. Therefore, $550 would be a partially amortizing payment.

What if you were to pay only $500? Since this mortgage payment just covers the interest, there would be no amortization, and the balance would remain at $100,000. The monthly payment would be interest-only.