What is Negative Amortization (NegAm or deferred interest)?

From time to time, I am asked by clients, loan officers and real estate agents, what exactly is negative amortization or NegAm.

Negative amortization occurs when the monthly payment is not sufficient to cover the interest portion of the fully amortized payment. Bottom line: the interest shortfall is added to the outstanding loan balance, thereby INCREASING it.

Here's a prime example of how it works:

Acme Lender offers a flexible adjustable rate mortgage, called the "SuperFlex You Pay What You Want Mortgage". John and Jane Doe apply for a $100,000 Superflex mortgage. They quickly discover that they have 3 payment options:

Fully amortized payment = $736 (based on a fully indexed rate of 8%). If Mr. and Mrs. Doe select this option, they will amortize their loan on schedule.
Interest-only payment = $667. If Mr. and Mrs. Doe select this option, they will not pay down any principal.
Minimum payment = $512 (based on an introductory rate of 4.5%). If Mr. and Mrs. Doe select this option, they will be adding the difference between the interest-only portion and the minimum payment back to their outstanding loan balance (in this case, $149 for that month).

Why would lenders offer such a mortgage? Profitability. Loan officers pitch this to consumers as a flexible means by which they can "control their monthly cashflow". This is not to say that negam loans are necessarily bad for consumers. Consumers simply need to be educated about the costs and risks associated with interest deferral. Of course, lenders do not permit borrowers to defer interest indefinitely.

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