Buying a property is a tremendous wealth building strategy for most Americans. If you are not careful, however, the strategy can go bad because of negative amortization issues.
Understanding Negative Amortization and Your Mortgage
The United States has a strong middle class, which makes the country one of the wealthier in the world. One of the foundational elements of this middle class is homeownership. Simply put, homeownership is a method for building wealth via paying off mortgages and realizing gains through appreciation. The government realizes this and provides incentives such as capital gains exemptions and mortgage interest deductions to facilitate further growth.
Homeownership, however, is not always a slam dunk. If you are not careful, you can get into a situation where you are realizing negative amortization and are actually losing money. To understand such a scenario, we need to discuss some basics of a loan.
In exchange for being loaned money, a lender expects you to make monthly payments against the amount due. The repayment of the loan is called the amortization repayment schedule. With most loans, your initial payments are mostly applied to interest. This can lead to issues if the loan is too good to be true.
In a competitive loan market, banks and lenders offer deals that may sound good but can hurt you in the long run. Many of the mortgages that fall in this area involve some variation of payment that does not address all the interest accumulating on the loan. While loans come in a wide range of formats, said loans generally are designed for you to pay less than the interest being accumulated on the borrowed amount with the idea you will sell the home in a relatively short period such as a couple of year. The problem, of course, is what if you cannot sell the home?
As you are probably aware, the current real estate market is stagnant and even receding in many locations across the nation. This means prices are pulling back form their peeks that were seen over the last few years. This trend should continue for at least a year if not more. The fundamental impact is that many people who bought in the last year or so now own a home that is worth less than they paid. In short, they are upside down. Now, throw in a mortgage that is actually growing because only partial interest payments are being made, and you have a disaster.
Betting on real estate market growth is not necessarily a bad thing. The market tends to consistently grow over time. In the short term, however, negative amortization can absolutely kill you so be careful.
Raynor James is with the site - FSBOAmerica.org - information on mortgage loans.
