All About the Amortizing Mortgage

Many people have one, but what exactly is an amortizing mortgage?  According to the experts, an amortizing mortgage is essentially a monthly payment plan that is used so that your loan is paid off over a specific loan period.  An amortizing mortgage is usually paid off in equal monthly installments.

Common examples of an amortizing loan are your car loan and your home loan.  In both these loan types, your payment is divided into two portions. The first part is the interest cost.  The other part is the principal amount.  In total, the principal amount represents the money that was originally borrowed from the lender.  The other part, the interest, represents the cost of borrowing the money for the agreed time period.

Amortization mortgage interest is calculated for each payment period at the start of the loan. The first payment is almost all interest and the last payment is almost all principal.  This means that the longer you have been paying for your mortgage, the more of each monthly payment will go toward reducing your debt.

What about negative amortization mortgages?  What are the pros and cons of this type loan?  Most payment plans for a negative amortization mortgage offer at least 3 different types of payment you can make each month:

1. Minimum monthly payment
2. Interest only payment
3. Full amortized monthly payment 

The minimum monthly payment is the negative amortization option.  This means that you are paying less interest than is due based on the amortization schedule--and that unpaid interest is added to the principal amount of the loan.  Over time, these minimum payments can lead to a much higher balance owed on the loan.  

The interest only payment does not add to the loan balance, nor does it reduce the balance.  It just pays the amount of interest due that month based on the amortization schedule.

The full amortized payment is what would be due if there was no flexibility in payment types for an amortizing loan.  It's the same as what was discussed at the start of this article.

The key benefit of negative amortization loans is the flexibility to make different payments by month as desired.  However, some borrowers who routinely make the minimum monthly payment later find they owe more on the property than what it's worth after covering selling and closing costs.  Responsible lenders will not recommend a negative amortization loan for borrowers who cannot afford to make at least the interest only payment each month.

What about payment caps or interest rate caps?  Many amortizing loans offer both yearly and lifetime caps on the level of interest rate increases.  Some also offer caps on how much the monthly payment can increase each year.  These caps help limit the risk of adjustable rate mortgages for the borrower.  This makes it easier to make your loan affordable.  If the interest rate on your loan rises so high that the interest on your loan exceeds the actual monthly amortization mortgage payment, the unpaid amount will be automatically rolled into the loan balance.  This will make overall balance grow over time.

Here is an example of how this can happen.  Let's say that the payment cap of your amortization mortgage is 7.5% per year.  And let's say that your monthly amortization payment is $1,000.  With rising interest rates, your new payment could end up being roughly $1200/month.  But with a capped payment, you will only have to pay $1075.  The remaining $125 will get rolled into your loan balance.  However, you can counteract the effect of negative amortization by choosing to pay the additional amount now.  That way, you will not be saddled with a higher principal balance when you sell or refinance.