Definition
Negative amortization is a repayment schedule in which the minimum payments pay less than the finance charges so that the balance increases rather than decreases.
Analysis
Negative amortization may occur with some exotic mortgage products that are designed for homebuyers that do not intend to occupy the residence long-term. The intent is to keep monthly payments low for long enough to improve the property for a sale.
Negatively amortizing mortgage loans became popular in some overheated housing markets. Homeowners were betting on their property values to increase faster than their loan balance, which would allow them to build equity while making a lower mortgage payment. This strategy may have worked for a few homeowners in the short term, but many homeowners faced substantial economic hardship when housing prices began to fall and their loan liability exceeded the value of the property.
Homeowners experiencing negative equity do not have the same lending options, since they have no equity to cash out. Additionally, they may have difficulty selling, since mortgage lienholders normally require that a sale price equal or exceed the loan balance.
