Wise Advice on Neg Ams

Negative amortization occurs only with monthly adjustables, called "Option ARM's" or "COFI ARM's" or "Choice ARMs" or “Pick-a-Pay”. With these products, you agree to pay a contractual rate, usually 1.5%, for a year, knowing that required principal and interest payment can go up by 7.5% each year thereafter. There is an underlying rate, though, and that is the rate at which your loan actually accrues interest. When you get the invoice, you have three choices: Pay all the interest and principal due, pay only your required payment, or pay only interest. The underlying rate is the sum of the index (let's say 1 yr US Treasuries, currently at 1.2%) and your margin (let's say 2.5%) - in this example, your mortgage is accruing interest at 3.75% (they round up to the nearest 1/8 of on percent). If you choose to make the contractual minimum 1.5% payment, the difference gets added to your principal, increasing the loan amount - causing the amortization to go "negative" because the principal is not going down, like a typical fixed rate loan would. It is an excellent product for folks who encounter temporary cash crunches, or investment properties with fluctuating rental income. It is not for those who lack financial discipline, however. Once the principal hits 115% of what you originally borrowed, the loan will be "recast", and you will have to either refinance or accept new terms at that time.