Owning a home is a big part of the American Dream and a big part of what makes someone middle class. Negative amortisation, on the other hand, can turn the dream into a nightmare if you are not careful.
Negative amortisation and home loans
When you get a basic home loan, it goes without saying that you have to pay it back to the lender. Usually, the loan is paid back over a certain amount of time and a certain amount is paid each month. This is what the amortisation repayment schedule is all about. In some cases, though, the way the repayment plan is set up can cause a lot of trouble.
Lenders of home loans have to fight for your business. To stand out, they'll come up with unique mortgage packages that make it easy for you to buy a home that might be a little bit more expensive than you can afford. One way to do this is through a method called "graduated repayment." With graduated repayments, your first loan payments are less than the total amount of interest you owe. The extra interest then builds up and is usually turned into the original loan amount.
This process, which is based on a bet, is called "negative amortisation," and it can be very risky. When you take out a loan with negative amortisation, you are betting that the value of the property will go up faster than the interest on the loan. If the value of your home doesn't go up, you'll eventually be making payments on a house that has no value. When the amount owed on the mortgage is more than the value of the home, you are suddenly upside down on the loan. In other words, the home has become a pure debt.
A lender won't just sit around and let the principal on a loan keep growing forever. So that this doesn't happen, the loan usually has a limit on how much you can owe. If you go over that limit, the loan automatically changes into a different loan and you start paying off the balance, or the loan may just come due. For example, the loan may say that if the total debt is more than 115 percent of the home's value, the loan will be due in full. Either way, it's a nightmare because you'll have to make payments you can't afford or find a lot of money quickly. Most homeowners lose their homes because of this.
When you are trying to buy a home that is just a little bit out of your price range, negative amortisation loans can look very appealing. Just make sure that in the long run, they won't kill you.
