Negative Amortization Loans: Are these Mortgage Options ARMed and Dangerous?

A conventional mortgage with a thirty-year period would be amortized over the thirty years. The monthly payment to the lender has two parts, one portion is a repayment of the principal of the loan, this is considered the amortization part of the payment, and the second portion of the payment is the interest on the loan. This type of amortization is not very risky.

Negative amortization mortgages could be considered very risky. In a negative amortization mortgage, the payments only have one part. The payment made to the lender covers only a portion of the interest earned. The balance of the interest earned is added to the mortgage balance, hence the term negative mortgage. The negative amortization is also called a "neg am" loan is a loan with an deferred interest loan that offers a low payment initially.

A danger is the loan balance exceeding the market value of the property. A secured loan may become unsecured and the ability to put a second mortgage behind negative ARM option loans may be questionable. If you aren't prepared for the deferred interest that could affect your home equity, then this loan is not for you. If you understand the risks, but need a low monthly payment to help you get in the right home, then this loan is for you. The difference between an interest only mortgage and a negative amortization mortgage is that in the interest only mortgage the payment covers all interest earned by the lender and the balance of the loan remains constant. The interest rate is so low that it is actually lower than the interest rates offered on an Interest Only Loan. Because this interest is so low, the interest is deferred and added on top of the principle balance of the loan.

The purpose of the negative amortization mortgage is to reduce the payments at the beginning of the loan. The loans may be either at a fixed rate or a variable rate. The fixed rate loan provides an even progression of the growth of the mortgage. With variable loans, the rate of growth will change from month to month depending on an increase or decrease in the index used to adjust the interest rate charged on the loan.

What are some of the indexes used with adjustable rate mortgages (ARM)? There is prime rate; this is what the banks charge their best customers. Many believe that the MTA-index and the COFI Option ARM are the best interest options offered today. Option ARM mortgages are becoming more popular as they are fully understood. The question is payments vs. lower interest rates. The lower payment option ARM increases the cash flow to pay off high interest credit lines or for debt consolidation.

Are option ARM mortgages any more risky then home equity loan mortgages, second mortgages, which can also produce negative amortization? First time buyers and those refinancing must carefully review all the options and decide what type of mortgage best fits there needs.