Amortizing part of your interest payment each month can help you weather a short-term financial storm.
It sounds like a mortgage deal too good to be true: your financial institution allows you to reduce your monthly payments to the point where you're actually paying less than the current interest charges due.
It's called a negative mortgage amortization, and if it sounds too good to be true, that's because it is. The money you save on interest now will cost you more later.
Typically, monthly mortgage payments are comprised of interest, which is a charge for the use of the mortgage money borrowed, plus a sum that goes toward the principal and reduces your actual debt. At the beginning of the mortgage term, most of your monthly payment is interest, and a relatively small amount goes toward the principal. Over time, the proportion gradually reverses, and the amount that goes toward your principal increases, while the interest you pay decreases.
A negative mortgage amortization is a type of Adjustable Rate Mortgage (ARM) that allows you to pay less than the full amount of interest due every month for a set period of time, usually a year.
Let's say that your normal monthly mortgage payment is $1,000 and that $600 goes toward interest and $400 goes toward principal.
With a negative mortgage amortization, your monthly payment on the same loan could be $500, which would go entirely toward interest. But you'd still owe $100 in interest plus $400 in principal. The $100 in interest is added to the principal of your loan, and you start paying interest on it, too.
So at the end of the month, you will actually owe more on your house than you did at the beginning of the month, and you will be paying interest on this increased amount until you retire your mortgage.
So your short-term gain - lower monthly mortgage payments - adds up to long-term pain. You end up with more mortgage debt than you had before and greater total interest charges. The longer the period of negative amortization lasts, the more you will owe.
Still, negative mortgage amortizations can make sense in certain circumstances. Let's say you have to take a break from work or run into an unexpected expense, but know you'll be on sounder financial footing in the future. A negative mortgage amortization can allow you to put some money toward your mortgage interest and keep your home. Once you're back on your feet, you can arrange to increase your monthly payments to make up for the interest you couldn't pay earlier, and even pay it all off in one shot if you have the money.
The risk is, of course, that your finances won't improve on schedule and you'll eventually be faced with a bigger mortgage you can't afford and a tough decision about selling.
A negative mortgage amortization can also be used to speculate on real estate. You can use one to live in a house inexpensively, while the value increases. You could then sell at a profit and use part of the proceeds to pay off the mortgage. But if the house doesn't appreciate, you are stuck with a great big mortgage.
So think twice about going the negative amortization route. While it can help you cope with a temporary shortage of funds, it's a risky business.
