There are many types of subprime mortgages, but one of the most predatory types of mortgages is the Negative Amortization Loan. Negative Amortization Loans can sound attractive at first, but after a few years, it is very easy to end up owing more money on your mortgage than you initially paid.
In a negative Amortization Loan, the monthly payment is less than the total amount of interest owed for that period of time. This difference is then added back onto the loan, which raises the total amount of money that is owed to the mortgage lender.
Negative Amortization Loans are sometimes called a deferred interest loan, Graduated Payment Mortgage(GPM,) or NegAm Mortgage. No matter what the name, if you are paying less than the normal amortization amount every month, you are in a very dangerous position.
Amortization is used to refer to how the payments of a loan will be used to pay down a mortgage. During normal amortization, part of your payment goes toward the interest of a loan and part of it goes towards the principal of the loan.
At first, more of each payment goes towards interest than principal, but over time, this reverses and you begin to pay more towards the principal of the home and less in interest.
To see how each of your payments are used, you can view an Amortization Table, which most lenders will freely provide you with. The Amortization Table will break down all of your payments by month, showing you how much principal you owe after each payment.
A negative amortization loan is when each monthly payment is less than the total amount of interest owed on the loan. The interest that is not paid is then tacked onto the principal of the loan. As a result, each month that you pay negative amortization, the amount you owe on the home increases.
So, as an example, say that during the first year of a 30 year mortgage, a normal mortgage payment would be $500 a month, with $400 going towards interest. In a negative amortization loan, you might only pay $250, with $250 getting added onto your total mortgage balance each month.
As a result, this not only increases how much you owe on the home, but it also increases the amount of interest you owe.
Due to legislation, this is usually only allowed to happen after up to five years, which is referred to as the recast period. However, in five years time, paying negative amortization can result in owing many thousands more than what you paid for the home and what it is worth, which makes selling the home very difficult.
Many people who have negative amortization loans end up short selling, which means selling the home for less than they owe. This is because the principal of the loan vastly exceeds the homes actual value, which is referred to as being underwater on a loan.
When negative amortization loans are coupled with an adjustable rate mortgage, which has an increasing interest rate every few years, it is very easy to end up underwater on the loan. When the adjustable rate increases, which it will, this means that all of the money added on by negative amortization, will also increase.
There are many problems with negative amortization mortgages, which often result in drastic increases in mortgage payments each month. This is often referred to as payment shock, where the amount owed month by month can rapidly increase after the recast period.
While negative amortization loans can be very dangerous, if you plan on quickly selling a home for a profit, it can be a good investment tool, as you will have a lower monthly payment. However, this is very dangerous, as if you can not sell the home or if the value of the home decreases, you will end up owing more than the home is worth.
Many first time home buyers get into trouble over these types of loans, because they have a very low initial monthly payment, which can seem very attractive. However, once the grace period is over and the rate increases, they soon realize they have entered into a predatory loan.
The current economic situation leaves much to be desired. Unemployment is up around the country and due to the bank bailout, we are facing a very large deficit, which has questionable returns. This and many other factors lead many to be very wary of what is to come, so it can be hard to find a silver lining. However, for those who are prepared to buy a home, now is a very good time, as home prices are at a historic low and the government is offering a tax credit for first time home buyers.
There are several reasons that house prices are so low, but it has a lot to do with the high rate of foreclosures. Over the last 10 years, the subprime mortgage market exploded.
Subprime mortgages are mortgages that have higher interest rates and less favorable terms than traditional mortgages.
Subprime mortgages have historically been a tool used by people who have less than perfect credit and would not be able to get a standard mortgage. One of the most popular subprime mortgage was the Adjustable Rate mortgage, which had a low initial rate that increases periodically. Not all Adjustable rate mortgages(ARMs) are bad, but subprime ARMs can have an interest rate that increases freuquently and exponentially raises the monthly mortgage payment.
Those who receive a subprime mortgage are still usually vetted by the lender, with credit checks and income checks to verify that the individual will be able to pay for the mortgage. However, over the last few years, many lenders stopped vetting loan applicants and instead approving pretty much anyone for a home loan.
Lenders stopped vetting mortgage applicants, because mortgages became a very popular investment tool. Investors would buy up a group of mortgages and then bundle them into a large group. They would then sell the mortgages to investors, many of who were overseas, as a high return investment. Since the bundled mortgages were subprime, they had a much higher than normal return rate.
The first investor, who financed the initial mortgages, would not be keeping the mortgages, so there was no incentive for the investor to vet applicants. Instead, as soon as they had enough mortgages in their bundle, they would sell them and be someone else’s problem. This resulted in many people who should not have had a mortgage ended up with a subprime mortgage.
One of the reasons that real estate became so popular as an investment tool was because of rapidly increasing home prices. Homes would often appreciate more than 25% a year towards the end, which gave the impression that even if the person defaulted on their loan, the home could still be sold for a profit.
This went on for some time, with home prices rapidly increasing, artificially inflated by the large number of subprime mortgages. However, this could not go on for ever and eventually those who received these subprime loans, were no longer able to pay for them, spurring a increase in foreclosures.
While the current housing market has brought much sorrow to many homeowners, there is a silver lining for some. With the vast number of foreclosures and empty homes, it is possible to buy a historically low prices. This large number of foreclosures has also driven the prices down on other homes. Further, interest rates are at an all time low.
Of course, lenders are now being much more careful in who they offer mortgages to, but for those with good credit and money for a down payment, it is possible to purchase a new home for much less than even a year ago. The federal government is also offering a tax credit for first time home buyers, which is up to $8,000 and does not need to be repaid, so for many, now is a good time to buy a home.
Many assert that housing prices were artificially inflated in the first place and the prices we see today are simple the real market value of the home, and in many ways this is correct.