Loan Advice

What Is A Negative Amortization Loan? I’ve Also Heard These Loans Called Pick a Payment Loans? Do These Loans Ever Benefit Anyone?

One of the loan types getting a lot of media attention these days is the Negative Amortization Loan(NEGAM). In general they are very poorly structured loans and at all costs should be avoided. However, you might be surprised to find out that this loan can, at times, be beneficial to certain types of borrowers.

First, what the NEGAM loan SHOULD NOT be used for:

The NEGAM loan is a terrible idea for someone who wants to buy a house that they cannot afford. One of the benefits of a NEGAM loan is that the minimum mortgage payment is extremely low compared to the interest only payment or principal and interest payment normally associated with a home mortgage. That is because the minimum payment only represents a portion of the interest only payment required each month. The remainder of the interest that is not paid each month is ADDED to the loan’s principal.

This might be fine during the first year. After all, the homeowner gets to live in a house they cannot afford by paying the minimum payment, but what most homeowners do not realize is that built into the NEGAM loan structure is a mechanism that after time brings the minimum payment up to and equal to the interest only payment. If you were not able to afford the interest only payment when you first bought the house, eventually you will not be able to afford your payments. This is especially true after all of that interest that you did not pay is tacked onto the loan, and your loan’s interest rate, and your minimum payment all adjust higher. At that point, you should have a few suitcases and a UHAUL ready, because your only option, like so many others who were seduced into this loan, will be to pack it all up and walk away.

One situation where a minimum payment loan could be beneficial is if a borrower already owns a significant amount of equity in the home or that the interest tacked onto the loan each month is insignificant. For example: you’ve been in your home for 20 years. You paid $135,000 for it then and now after time it has a value of $475,000. An extra $800 or so added to the principal is pretty insignificant.

In some cases it could be beneficial for a borrower to acquire a NEGAM loan and make a minimum payment, especially if he’s just been hit with unexpected medical bills. It might be far more important pay off those medical bills than to make a full interest only payment.

Another time, I suggested a minimum payment loan to a writer who was low on income and savings because she was devoting her time to her latest novel. In this case she had about $300,000 in equity, so a year or two of minimum payments would help her get through a financially tough time, before her novel was published.

Having shown you a couple of occasions where a minimum payment could possibly be beneficial, I still strongly suggest that under normal circumstances a homeowner stay as far away from a NEGAM loan as possible.