Neg Am Loans (OH NO!)

Neg-Am, or negative amortizing, means that as you make your monthly payments the loan balance increases rather than decreases. This is exactly the opposite of what anyone would want to happen, right? After all, even when you make the required minimum payment on your credit cards, the balance goes down and eventually the card will be paid off. So why would anyone want a negative amortizing home mortgage? In a word - cash flow.

To understand the benefits of a neg-am, the mechanics of the mortgage need to be understood first. Adjustable rate mortgages are “built” by taking an index and adding a margin to that index. Some of the more popular indexes for first mortgages are: 1 year Treasury bill, 6 month LIBOR (London InterBank Overnight Rate), Monthly Treasury Average (MTA), or the perceived favorite- the 11th District Cost-of Funds or COFI. Whatever the index is, the lender cannot control it. To this index the lender adds a margin, anywhere from 1 percent to 5 percent, depending upon various factors such as credit score, cost, risk or even greed!

The index that is offered by the lender can move daily, just like stocks in a stock market. Since the index is always in flux, the lender may offer to “fix” the rate over certain intervals. Those intervals can be as long as 10 years or as short as daily. The more “adjustable” the rate period is, the more risk for higher interest rates is assumed by the borrower.

Up until this point we have been speaking strictly about the interest rate and how it adjusts.

The payment can change at the same adjustments as the rate, or the payment can change at other intervals. In other words, the interest rate may change monthly while the minimum payment may change yearly. In most cases, adjustable rate mortgages that are referred to as 6 month, 1 year, 3 year and so on have the payment and rate adjust at the same time (check the mortgage note). As payments are made, the loan is paid off on a 30 year schedule. For a negative amortizing mortgage, the minimum payment is changed annually while the rate changes monthly. An adjustable mortgage that starts at 2.95% usually means that the rate and payment is at 2.95% for the first month only. In the second month, the rate may jump as high as 6.5% while the payment stays at the 2.95% level. What happens to the interest differential between the 2.95 and the 6.5? That unpaid interest is added to the balance of the loan to be paid at a later date, thus the loan balance is increasing or negative amortizing. The borrower always has the option of paying the higher rate to avoid the neg-am.

So, back again to the original question, why would anyone want a neg-am loan?
Monthly adjustable mortgages are sometimes the perfect tool for business owners, commissioned salespeople, or any homeowner whose income can fluctuate from year to year. The home mortgage payment is the biggest monthly outlay for most people. To use this mortgage to your advantage, you would make the minimum monthly payment throughout the year, then near the end of the year when you know if you are having an “up year” as related to taxable income, you could then pay any deferred interest. Since the deferred interest is mortgage interest, it is generally tax-deductible reducing you tax liability. If your income is down for the year, allow the mortgage to neg-am and use the available cash for other bills.

This strategy isn’t for everyone and anyone contemplating this should consult his or her accountant or financial planner. Just don’t discard a neg-am mortgage before you have all the facts.


Conforming fixed rate mortgages for loans under $300,700 as of 7/16/02 (p.m.) are:

30 year: 6.125% (APR: 6.414%) monthly payments are $1,827.09/mo.
15 year: 5.375% (APR: 5.845%) monthly payments are $2,437.07/mo.