What is a Neg Am Loan? Amortization vs. Negative Amorization

In the past, home buyers scrambled to get into as much home as they could afford in some of the hot real estate areas, just to participate in the heady 20-30% gains. To maximize their investment dollars, they took on negative amortization loans and kept buying. Now that the real estate market has, ‘ahem’, softened, the media and the government are all over loan companies for their use of these loan products. But for better or worse, there is power in neg am loans and you should know whether this type of loan is for you, that is, if they are available (as of 2010, these loans were just about impossible to find).

Your loan amount usually consists of principle (your equity) and interest. The mortgage industry has already given people the ability to forego paying principle by interest-only loans. But with a neg-am loan, you can avoid paying all the interest you owe every month. You’ll pay less every month, and the interest you don’t pay gets tacked on to the amount you owe.

For example, the monthly mortgage payment (principle and interest) on a 30-year fixed-rate loan of $100,000 at 6% is about $600. In the first month, the interest due the lender is $500, leaving $100 for principle. The balance at the end of month one would be $99,900. Now let’s say you only pay $400 the first month. That means you paid no principle and less interest than you owed. After that payment, you’ll actually owe the lender $100,100. This rise in your loan amount is called negative amortization, or “neg am”.

Neg am loans are good for some and not for others. Investors love the neg am loan in a rising market. It allows them to control more real estate when prices are going up. However, even investors need to make sure that they have enough cash buffer in case of a market correction. If you need to sell and your home is worth less than you owe on it, then that money is coming out of your pocket.

Neg am loans can also be appropriate for those with an unsteady income or an income that may be rising quickly. An Option ARM is a type of neg am loan that allows you to choose whether you want to pay only a minimum amount each month, or the full interest amount.

What experts are fussing about is the ability for homeowners to get themselves into financial trouble. The fear is that when it comes time to sell, neg am users will find themselves with little or no equity to show for their years of home ownership. Before deciding whether neg am loans are for you, determine your purpose and your attitude towards debt.