Differences Between Negative Amortization and Reverse Mortgages

Negative amortization mortgages and reverse mortgages may seem to be the same thing at first, but they’re actually not. These two types of home loans both have principal balances that grow instead of decrease over time, but the reason this happens is completely different in each case. Understanding the difference between a negative amortization mortgage and a reverse mortgage will help you determine what type of loan is better for you.

Negative Amortization Mortgage

In the case of a negative amortization mortgage, you make partial payments toward your mortgage balance. Your monthly payment only covers some of the interest due and the difference that isn’t paid is then tacked on to the loan principal. This results in the principal balance of your loan increasing over time, rather than going down. The principal amount of a negative amortization loan grows because of deferred and partial payments.

Negative amortization is most common with adjustable rate mortgages (ARMs). Many times, those who specialize in “flipping” properties opt into ARM loans because they do not expect to hold onto the property long enough to have to pay the increased rates that happen during the course of the loan cycle.

Reverse Mortgage

Only people who have already built equity in their home can use reverse mortgages. A reverse mortgage is a loan that taps into that established equity and provides you with a portion of the value in cash that does not have to be paid back until the home is no longer your primary residence.

The interest on a reverse mortgage loan is compounded and added onto the principal interest, thus making the principal amount grow. Although it appears to work like a negative amortization mortgage, you can see that it’s a very different situation. The principal of a reverse mortgage grows because of compounded interest, not because of deferred payments.

These two types of home loans serve very different purposes. One of these options may be appropriate for you, depending on your individual goals. Learn more about how each work to find out if either a negative amortization or reverse mortgage is right for you.