Concern Over Negative Amortization

Concern Over Negative Amortization
Many of our clients have expressed some concern over the potential for deferred interest or negative amortization in this type of mortgage. While it is immediately obvious that you are in control over when you choose to use the minimum payment rather than the interest only payment, we do recognize that many will use the minimum payment option and will create some negative amortization balance. This page will show you just how small a rate of appreciation will be required to offset the use of the minimum payment every month.
Example:
Appreciation vs. Negative Amortization
$300,000 loan at 80% LTV
Fully Indexed Rate increases to 7.5% in month 2 and remains constant for 1 year ( high rate by today's standards but we want to show a worse case.
Minimum payment rate 1%
Interest due:                $1870.53 ($299,285* x 7.5%/12 months) *unpaid principal balance after first payment
Minimum payment:    $ 964.92   (1% rate calculated as a P&I payment for 30 years)
Difference                  $ 905.51      ($1870.53 - $964.92)
Annual amount           $ 10,867.32 ($905.61 x 12 months)
Annual negative amortization or deferred interest            $10,867.32
Divided by Original market value of the home                 $ 375,000
Appreciation needed to offset negative amortization        2.90%
If you selected the minimum payment every month, at a 2.90% appreciation rate, you break even from an equity perspective, greater appreciation gives you more equity. If you invest the $10,867.32 in any investment paying greater than 1% you are even better off than at the beginning of the mortgage.

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