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Unformatted text preview: erest due on the loan. “Negative amortization” may occur if an ARM contains a payment cap. Negative amortization means the mortgage balance is increasing because monthly mortgage payments are not large enough to pay all of the interest due on the mortgage. Increased Debt – The interest shortage in each payment is automatically added to the debt, and interest may be charged on that amount. The borrower might, therefore, owe the lender more later in the loan term than at the start. However, an increase in the value of the home may make up for the increase in what is owed, so an ARM with negative amortization may still be an acceptable risk. Example: Negative Amortization
Using the figures from the preceding example, here is how negative amortization works during one year. The first 12 payments of $570.42, based on a 10% interest rate, paid the balance down to $64,638.72 at the end of the first year. The rate goes up to 12% in the second year. But because of the 72% payment cap, payments are not high enough to cover all the interest. The interest shortage is added to the debt (with interest on it), which produces negative amortization of $420.90 during the second year. 9-24 Licensing School for Appraisal, CPA, Contractors, Insurance, Real Estate, Notary, Nurse, Food Handlers, Tax and Securities 9: FIXED RATE MORTGAGE AND ALTERNATIVE MORTGAGE INSTRUMENTS
Beginning loan amount = $65,000 Loan amount at end of first year $64,638.72 Negative amortization during 2nd year = $420.90 Loan amount at end of 2nd year = $65,059.82 ($64,638.72 + $420.90) If the house is sold at this point, the owner would owe almost $60 more than the amount originally borrowed. Increased Payments – The payment cap limits increases in monthly payment by deferring some of the increase in interest. Eventually, the borrower will have to repay the higher remaining loan balance, at the ARM rate then in effect. When this happens, there may be a substantial increase in the monthly payment. Negative Amortization Caps – Some mortgages contain a cap on negative amortization. The cap...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10