Definition - What does Negative Amortization mean?
Amortizing a loan allows a borrower to repay a loan by making multiple cash payments in installments according to an amortization schedule. For example, a home mortgage loan can be repaid, with payments consisting of both interest and principal payments. While the loan payment is the same each month, the amount of the payment applied toward the principal increases at the end of the loan repayment period.
Negative amortization, however, allows borrowers to pay a minimum amount each month by avoiding interest payments. Instead of paying off the loan in regular installments, the borrower is simply deferring the interest payments, which are then added to the principal balance that must be paid at a later date.
Justipedia explains Negative Amortization
Negative amortization loans were popular prior to the housing market crash of 2008. Home buyers loved the loans because they allowed them to purchase large homes with lower monthly payments, many with the intention of keeping the house for a short time and “flipping” it for a large profit.
Unfortunately, when the home market declined, home buyers who had purchased homes with a negative amortization loan found that not only did they owe more for their home than they owed at the loan’s origination, but their monthly payments had risen substantially and they were no longer able to sell their home for a profit.
At this point, many home owners were either forced to sell the home for far less than the true value of the property, declare bankruptcy in an attempt to save the home, or allow the lender to foreclose on the property.
Other home owners, who had a purchased a home with a more traditional home loan, were more likely to have bought homes that they could actually afford, and many were able to weather the financial housing storm and keep their property until the housing market rebounded.