Amortization

Almost everyone has a loan that is repaid over a period of time, whether it is a car loan, college loan, or home mortgage. Making gradual repayments of a loan by installments is known as amortization. These payments cover interest costs and a reduction of principal, or the amount of the loan.

However, there are times when negative amortization occurs. Negative amortization is when payments are being made, but the balance of the loan continues to increase. This usually happens when interest rates increase enough so that monthly payments do not cover the monthly cost with interest. For example, the monthly payment is $300, but the monthly cost with interest is $325. Therefore, $25 is added to the original debt and results in an increasing debt, or negative amortization, and could result in having a larger debt than the original amount.

Making full monthly payments on time to avoid fees being charged can prevent negative amortization. Fees that are charged to an original debt can become interest bearing, which will increase the debt. If interest rates increase, monthly payments will need to be adjusted to prevent negative amortization from occurring. Interest rates may increase without adjusting the monthly payment due; therefore, constant awareness of the loan's balance and interest rate is needed to avoid negative amortization.

The above information should be understood to be a general discussion of the subject matter and DOES NOT constitute a legal opinion about the situation. For further information please consult a qualified attorney.

Back to Basics Of