What is a Negative Amortizing Loan?

Video Transcript

Okay, so all these institutions, they keep sending me these advertisements about the one quarter percent, but I don't know exactly how does this work. Okay yeah, that is a great question. I know a lot of people, myself included have gotten things in the mail for a one percent loan, low payments and things like that. Those have become more prevalent, they have been around for a while but have become a lot more prevalent in the last couple of years and are under a lot of screwnty in the investigating for their misleading nature. Those loans are called a Negative Amortizing Loan or a NEG AM LOAN and the way those loans are structured and they reason why they are misleading is because they offer different payment options. They offer your principle and interest payment or your P&I like we have talked about before, then they offer an interest only payment. And then they offer what is called a Minimum Payment. Okay, now we will say on this your true interest rate is, just for example we will say it is seven percent. So for you to make your Interest Only Payment to the bank, you are going to pay seven percent interest. I will give you an example; if we are dealing with a hundred thousand dollar loan, seven percent is seven thousand dollars a year, that is how much the bank makes. Then they say you can make your Principle and Interest Payment which is what would get it paid off. Okay, interest only pays what you owe the bank, it doesn't pay what you borrowed. Alright? The Principle and Interest Payment then is broken down and amortized, you can make as much or little of principle you would like. Then they offer a Minimum Payment at like one percent or two percent depending how they structure it. Now your true interest rate, like I said is seven percent. Which on the hundred thousand dollar loan example, the bank gets seven thousand dollars a year. Okay? They allow you to make your payment based on one percent which is one thousand dollars a year. Do you notice a difference between the two? That difference between the two, the banks then take and roll back into your loan. So there is a six thousand dollars difference. Now that is just in the interest rate. On the Minimum Payment, they will also make you pay some principle based on the amortization. So your true payment there is, we will say that is thirty five thousand dollars a year. So the actual difference between the two is twenty five hundred dollars. I'm sorry thirty five hundred dollars, excuse me. So that thirty five hundred dollars, that is what you owed them and didn't pay, they let you not make that payment so this is what is called Negative Amortization. That thirty five hundred you still did owe, but instead of paying it out of your pocket, you have paid it out of your equity. So now your used to be hundred thousand dollar loan is hundred and three thousand, five hundred. Okay and that happens every time you make this Minimum Payment, your loan balance grows. Most people don't understand that and they think oh, okay I can make this Minimum Payment and I am fine and that is because they weren't educated or explained how this program works. This program they say is a huge reason people are in this foreclosure situations because once you have a certain amount of your equity gone, this Minimum Payment isn't an option anymore and now you are stuck making at least your full interest payment or sometimes your Principle and Interest Payment. Okay, so those are the four main loan programs; there is your Fixed Rate Loans, your Balloon Loans, your Adjustable Rate Mortgages or your ARMs, and your Negative Amortizing loans or your NEG AMs.

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