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HOW CAN I REDUCE MY RISK? (continued)
Negative Amortization
If your ARM contains a payment cap, be sure to find out about
"negative amortization." Negative amortization means the mortgage
balance is increasing. This occurs whenever your monthly mortgage
payments are not large enough to pay all of the interest due on your
mortgage.
Because payment caps limit only the amount of payment increases,
and not interest-rate increases, payments sometimes do not cover all of
the interest due on your loan. This means that the interest shortage in
your payment is automatically added to your debt, and interest may be
charged on that amount. You might therefore owe the lender more later in
the loan term than you did at the start. However, an increase in the
value of your home may make up for the increase in what you owe.
The next illustration uses the figures from the preceding example
to show how negative amortization works during one year. Your first 12
payments of $570.42, based on a 10% interest rate, paid the balance down
to $64,638.72 at the end of the first year. The rate goes up to 12% in
the second year. But because of the 7.5% payment cap, payments are not
high enough to cover all the interest. The interest shortage is added to
your debt (with interest on it), which produces negative amortization of
$420.90 during the second year.
Beginning loan amount = $65,000
---------------------------------
Loan amount @ end of first year = $64,638.72
Negative amortization during 2nd year = $420.90
Loan amount @ end of 2nd year = $65,059.62
($64,638.72 + $420.90)
(If you sold your house at this point, you would owe almost
$60 more than the amount you originally borrowed.)
The above text was extractly directly from the Consumer
Handbook On Adjustable Rate Mortgages, as published by the
Federal Reserve Board and Office of Thrift Supervision. Although the above
text is public domain, this electronic booklet is copyrighted © 1996
by Mortgage Market Information Services, Inc. Readers of this electronic
booklet are allowed to print the booklet for non-profit distribution
Pg 1 -- Introduction and credits
Pg 2 -- PEOPLE ARE ASKING
Pg 3 -- PEOPLE ARE ASKING (continued)
Pg 4 -- WHAT IS AN ARM?
Pg 5 -- HOW ARMS WORK:THE BASIC FEATURES
Pg 6 -- FEATURES (continued)
Pg 7 -- CONSUMER CAUTIONS (Discounts)
Pg 8 -- CONSUMER CAUTIONS (Payment shock)
Pg 9 -- HOW CAN I REDUCE MY RISK?
Pg 10 -- REDUCE MY RISK (continued)
Pg 11 -- REDUCE MY RISK (continued)
Pg 12 -- REDUCE MY RISK (continued)
Pg 13 -- REDUCE MY RISK (continued)
Pg 14 -- WHERE TO GET INFORMATION
Pg 15 -- INFORMATION (continued)
Pg 16 -- GLOSSARY
Pg 17 -- GLOSSARY (continued)
Pg 18 -- MORTGAGE CHECKLIST
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