When it comes to home loans, there are many different types of mortgages available for prospective homeowners to choose from. Banks and other mortgage lenders in the financial services industry have created several variations of the home loan in order to make financing a new home or property purchase easier and more convenient depending on different needs of individual borrowers. One of these specific kinds of mortgages is the negative amortization mortgage. While that may sound like a mouthful, a negative amortization mortgage is actually pretty easy to understand.
How Negative Amortization Mortgages Work
In order to understand how a negative amortization mortgage works, you first need to understand how a fully amortizing mortgage works.
A fully amortizing mortgage takes your monthly mortgage payment and applies a specific sum, usually the majority of the payment, toward the interest that is being charged on your loan principal. So if your mortgage is $1,000 a month, $800 of the total will go toward paying off the interest accrued over the month. The remaining $200 will go toward the loan principal. If the loan principal was $100,000 at the time of the payment, for example, it will now be paid down to $99,800. That will be the amount you pay interest on next month.
In the case of a negative amortization payment, let’s say interest charges come to $800 per month on the loan of $100,000, but you agreed to only pay $600 a month. With a negative amortization mortgage, you still owe the remaining $200 in interest and haven’t paid anything off on the principal. The $200 is then added to the loan principal. At the end of the first month, the principal amount you owe will increase to $100,200.
As you can see, a negative amortization mortgage allows you to reduce monthly payments, but you’ll draw out the length of your loan and pay much more in interest overall.
Be careful not to confuse negative amortization and reverse mortgages. They may seem the same at first, but actually work quite differently. To find out more about negative amortization mortgages or any other kind of mortgage, be sure to consult with your financial advisor or bank representative who specializes in mortgage loans.
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