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Negative Amortization

It's topsy-turvy time.

Most mortgages work by having you repay the loan and make your loan amount or principal smaller over time. With a negative amortization mortgage (or "neg am" loan if your banker is trying to sound hip), the amount you actually owe outside of interest (the principal or amount you have borrowed) grows with time.

Why would you want a loan that doesn't get repaid and keeps growing? Well, maybe you like things that keep on giving. But more likely, you get this mortgage because you're older and don't expect to repay the loan at all.

YOLO

Let's say your grandma still has a mortgage that she's been paying off for years now. There's $300,000 left to repay. She's not getting any younger, and those pesky mortgage payments are preventing her from buying you that trip to Aspen or a new car.

She decides to go with a neg am mortgage, and now her mortgage payments are more reasonable. She's paying less than the interest rate on that $300,000 so she has some money in her budget to try sky-diving, bungee-jumping, and all the other fun stuff that make her feel young again.

If she lives another ten years, her loan amount might have increased to $500,000. If she leaves you, her absolutely favorite grandchild, her $1 million house, you can still get $500,000 pre-tax and you can enjoy all those pictures of the two of you white-water rafting over the last three years.

Love you, Nana.

Negative Amortization Math

On paper, neg am loans can look like adjustable rate mortgages (ARMs). Take a look at the paperwork and you'll see

  • an initial rate. This is the rate you'll be paying at first, for a specific number of months or years.
  • a step up. Once the introductory rate is over, this is how much the interest rate is likely to go up.
  • an index. This is what the bank will use to set the new rates. It is usually a Treasury Index or LIBOR.
  • a cap. The maximum amount the bank will charge in interest on the loan.

Reverse Mortgages

Granny can also choose to get a reverse mortgage. This stops all mortgage payments but sells a piece of the house to the bank (on paper—no one's going to take the flower garden away). While Granny is around, the bank pays her or simply stops sending her mortgage bills (depending on the agreement). If there's any equity or value left in the home when Granny is gone, you or her heirs will get it.

Reverse mortgages are attractive if someone has paid off their house but needs money to live now and also needs a place to hang their hat once they're done shopping. They're also an option if someone is having trouble making their mortgage payments. But they're not ideal if you're still young and can work since it means losing value or equity in your home (you want to be building that when you're young so that you can use it if you get a hankering for hand-gliding when you're 70).

Hopefully, you won't need these mortgages for a long time—or ever, if you invest and have an annuity or retirement fund to live off when you're in your golden years. But it's still nice to know that if you've worked hard, you have these options.

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