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Neg Am Mortgages

Posted by: Peter Coy on June 30, 2005

Yale economist Robert “Irrational Exuberance” Shiller thinks the U.S. housing market is forming a giant, soapy bubble that’s going to pop.

It might seem strange, then, that Shiller said nice things in his last book about “negative amortization” loans. With a neg am loan, you don’t pay all the interest you owe each month. Unpaid interest gets rolled into the principal owed, which goes up and up.

So why does Mr. Irrational Exuberance like neg am loans? Interesting question.

First of all, let's be clear--Shiller isn't moonlighting as a mortgage broker who gets people over their heads in debt.

The positive reference to neg am mortgages appears in Shiller's 2003 book, The New Financial Order: Risk in the 21st Century. (Pages 209-210.)

He's talking about the early 1980s, when inflation was raging and rates on 30-year fixed mortgages briefly got as high as 20%. (Yow!)

That was a different world. With such high mortgage rates, many people simply couldn't afford to buy homes. Sure, the fixed monthly payment would look cheaper and cheaper as the years went by because of high inflation. But in the beginning, before inflation had a chance to do its wonders, the payments were simply prohibitive.

That's where neg am fixed-rate loans came in. Your monthly payments, instead of being flat, would go up year by year. Not a bad idea: the cost to you would remain roughly the same in real dollars over the life of the loan instead of going from chokingly high to ridiculously low. Houses became affordable.

The catch, of course, was that borrowers didn't pay all the interest they owed in the early years. The unpaid interest got added to the principal. But later, as payments rose (in line with inflation), all the principal would eventually get paid off on schedule.

All in all, a neg am loan with a fixed interest rate was a sensible product at a time of extremely high inflation and interest rates.

Unfortunately, the new neg am loans are a very different and more dangerous breed. Most of them are in the form of "option ARMs," where borrowers choose each month how much they want to pay. The minimum payment is the one that can lead to negative amortization (i.e., where the amount you owe keeps going up).

There are two big differences from the early 1980s:

--Inflation and mortgages rates are lower, wiping out the main rationale for neg am loans. (Payments don't have to start out extremely high when inflation is low.)
--Most of the neg am loans have adjustable rather than fixed rates, so negative amortization can pile up more quickly. They're set up so when the loan's index rate goes up, the payment goes up less or later. The difference is piled onto the principal due.

Of course, just because you have an option ARM doesn't mean you have to make the minimum payment. But that's exactly what most people are doing, says David Liu, director of the mortgage strategy group at UBS.

Why? Maybe because it's human nature to pay as little as you can and hope tomorrow will take care of itself. Or maybe because some people bought houses that they couldn't afford and simply can't amortize the principal on their loans.

I sent Robert Shiller an email today asking him what he thinks about the new generation of option ARMs. I'll let you know what he says.

Reader Comments

David Porter

July 4, 2005 1:49 AM

I was reading your article today and have similar concerns with the Neg Am Loans that are being "sold" these days.

Don't get me wrong, I don't believe that this product is a bad product. I just believe that most people using this product today shouldn't be.

In Michigan, where you have to look real hard to find any appreciation right now, I believe this is a particularly bad product. However, the banks that call on me each week are all excited about how hot this product is. I would never use this product myself, in Michigan, why would I suggest it to anyone else?

In Arizona, however, where I have a second home. This was the mortgage of choice for me. My real estate holdings more than doubled in value in three years so I did a 1031 Exchange and rolled the money into a much bigger property. With this property I decided to use the 12 Mat Neg ARM Loan.

I did this for two reasons:
1.) I can better use the cash flow with other investments.
2.) I am confortable that the property will grow in value faster than my mortgage balance will grow each year. If I find that I am wrong, then I can always make an "interest only" payment, or one that has principle if I so choose.

The point I am trying to make is that those who are using this loan to make ends meet, should run away from this loan. It will only hurt them. Most Americans largest asset, in retirement is their home, this loan will eat away at that equity.


October 15, 2005 2:05 AM

i recently just refied on this neg am loan. I did not reakize this is what this was. I am now stuck in a loan that I hate and am against and i found out that my prepsyment penalty is 10,000. dollars.


October 20, 2005 9:56 PM

I like to reply to Lori's comment on Oct. 15.
I'm a loan officer and a Realtor. I like to let you know that the reason you have prepay penalty and not knowing it, it is because of your loan agent, who did not advice you that there's a prepay penalty. And the reason he/she put you on prepay penalty, because he/she makes more commission out of your loan by putting you on prepay penalty. Prepay penalty has nothing to do with MTA loan.

AWFinancial, Inc.

November 16, 2005 2:38 AM

What the Real Estate Expert above told you is absolutely right. As a Loan Officer at an established company, I have seen people in certain situations in which the NEG AM Loan makes sense. Those situations are; Investing or Commission Income (Unsteady Income), and that’s about it. The number one rule in the practice of Real Estate Mortgage is that if it isn’t beneficial to the borrower, then it should not be done. The common feeling around our office about a NEG AM loan is it’s soon to be extinct, maybe within a year or so. From what I can see, about 80-90% of the people on this program shouldn’t be on it, and about 75% don’t even know they are on it. Bottom Line: If you are on a NEG AM, and are not investing, you are losing money every month. Call American Wholesale Finance, Inc. At (818)974-1454 for more information or to get of this loan program.

Randy Fann

December 8, 2005 2:25 PM

The loan officer above is mostly correct. There are other reasons why and how one's profession and income make the monthly adjustable the product of choice. He/she is correct that the program should be what is best for the borrower. And I agree that most people have not been told enough about the program for them to make an educated decision about the loan. But as far as the program going away, that would be too bad for the clientele enounced ... investors, self-employed, commission only, and seasonal workers.
The program will not go away. It may be altered to prevent those who do not know the program or those who seek only their own benefit to be able to handcuff borrowers with it. But that loan officer, advertising him or herself, in California, should know that "you are losing money every month" is not a true and complete statement. As mentioned in earlier emails, appreciation is a large consideration. Michigan does not appreciate like California or Arizona. Plus the per month savings over a fixed or fixed-period product. Two positives to one negative ... it's up to the loan officer and the customer to evaluate whether the benefit works for them.


December 27, 2005 1:50 PM

There are some true staments even though i do not agree with all of them. A neg am loan is not as bad as some people had being told actually it can be the best option for different situations finding a loan officer that will explain each loan is what makes the difference.


January 5, 2006 9:39 PM

No loans that were taken in these past couple of years are really bad loans, since equity is surpassing the principal payment. What happens when property stops appreciating, the market has been bullish for to long and has a major phsycological effect on people that the government will save them just like 9/11. The housing industry in time and I mean near future will be more devastating than 9/11 because of how many lives are affected by housing, tech fine, but this is your roof over your head your gambling on.


February 4, 2006 8:27 AM

Everyone above is correct. The neg am is risky but also a good loan. I am a loan officer and my job is to let my client know about all the loans I can offer them. I suggest the neg am to the ones that I feel can benifit from it. The reason why people have trouble with this loan is because too many loan agents don't let the borrower know what this loan does or how to use this loan. They are really giving a bad service and a bad name to other loan agents. I have this loan for myself. The reason why is because I know how to use this loan to my advantage. Because of the savings of this loan, I have been able to buy other properties and make money on a monthly bases. I don't wish to wait 30 years to pay of my home or start investing. I would rather use the equity for other investments and know that there is still a payment that I can make in cases a rainy day comes along. Most people that pay their home off, infact never have a chance to enjoy or use the equity that they have made on thier investment. Who wants to refinance after paying a home for 30 years, and who wants to sell when most likely you'll be retired and not have payments anymore. So all the equity is never used. In my opinion the loan is good if you are fully aware of what it includes and know how to use it. It's too bad that not everyone in this business is honest and fair, and that is why people end up loosing with this loan.

Vanessa Valenciq

February 8, 2006 11:08 AM

I totally agree on your comments that they are several loan agents that dont give you the best advice on how to use a negative amortization loan.
I am planning to buy a home in orlando florida. What are your suggestions for this type of loan?


February 16, 2006 3:56 PM

I am actually on a neg-am loan in the SF Bay Area, i've been quite hesitant to stay on a loan like this for reasons stated above. Anyone know what the rule of thumb is on how long one should stay on this type of a loan?


March 29, 2006 1:10 PM

I am also on a neg-am loan and was not fully informed of all the penalties and details of the loan at the time of our house purchase. I have been trying to get out of it with the least amount of headaches and cost but the more I look into it the more hope I lose. Any ideas about what is the best way to go around this? The neg-am is for 5 years with the posssibility of refinancing after 3. we have been on it a little over 1 1/2 years. Looking forward to your suggestions and comments.
Ana the loan fool


April 7, 2006 1:28 AM

My husband and I are buying a house and are starting out with an Option Arm (neg am) loan. We plan to refi in 3 years or so at a regular amortized schedle when we are in a better financial situation. Houses have increased so much in value in the past year, and although they have flatlined recently, I believe the area we are buying in will be increasing significantly over the next years. I would love any input anybody would have for me.

juan partida

April 8, 2006 10:34 PM

is it true that you have to leave at least 5% if you want to cash out 100% for the reason to qualified for the neg am.

Sergio Aguirre

April 16, 2006 6:16 PM

Well lets face it --- americans want wine on a beer budget

First and foremost as a loan officer I let all my clients know what this loan is before I even explain why they would need it.

If your house is appreciating at 15-25% a year and you can get a fixed neg am for at least 10 years you will be doing yourself a big favor.

At 1.25% or even 2% the monthly cash flow you save can better be invested in portfolio assets which can be tapped if needed. Solid blue chip stock that pay dividends are something I would invest in with the extra cash.

The 4% of interest you dont pay obviously gets rolled back onto the house but if your equity is rising at even 8% your doing fine and actually making progress in my opinion because your cash will grow at 10-12% a year as well.

Cash in hand is always better than equity and having some portfolio assets as well as equity is a better spot to be in than just pure equity.

I feel for solid customers who can budget properly, a fixed neg am is a smart plan that allows them to use their cash flow to its fullest extent while maintaining the life style which they feel comfortable with.


May 13, 2006 12:35 PM

I totally agree on your comments that they are several loan agents that dont give you the best advice on how to use a negative amortization loan.
I am planning to buy a home in orlando nigeria. What are your suggestions for this type of loan?


May 13, 2006 12:59 PM

It's called arbitrage. It's the most powerful tool the average American has to create wealth. Who cares if it's neg am money. My average client has 20k in high interest credit card debt. Borrow the money at even a doomsday 10% fully indexed rate (if the naysayers predictions come true and the rates go that high)and pay off credit card debt at 12%-18%. Plus the interest is tax deductible. Then you can leverage this new found monthly wealth and accelerate the payoff of the neg am first or as so brilliantly listed above invest in real estate, why?, because if when you bought your current home, you bought the home right next to it and rented it out, you would within 12 years (at the average nationwide appreciation rate) be able to pay off the mortgage on your primary residence with the equity from the home you bought next door. Now, what if you would have bought 3 homes, or 5 , or 10? -OR- If you just want to get out of debt, in mathematically determined increments you pay down the first mortgage balance using a HELOC. Deposit your paycheck each month onto the HELOC, lowering your average daily balance, and create a mortgage savings account. Overall you'll pay the home off in 7-10 years, save hundreds of thousands of dollars in interest charges, and have an effective interest rate on your first mortgage of 2-3%. Math doesn't lie, just do the math.

Loan Guy

May 16, 2006 2:42 AM

I believe the Neg Am "Option Arm" is not clearly explained to all potential borrowers and it should be reserved for the more financialy savy borrowers. This loan product has become so popular in the marketplace not because of its financial advantages such as increasing cash flow for investment opportunities, but rather it has been aggressively marketed to the average consumer as giving them "the lowest payment" Let's face it, in certain areas of California the housing prices are astronomical and often times the only way to afford property is through "interest only" or neg am mortgages. The underwriting guidelines and standards to qualify a borrower on this product have become so flexible that in some instances a borrower is not required to verify income or assets to qualify. Also, the guidelines for this product have allowed borrowers to qualify with a 30 day mortgage late in the last 12 months, with credit scores down to a 620 (not a good score). Whenever you combine these flexible aggressive underwriting guidelines created by lenders with large commissions paid to originators the mortgage sells itself. Easy to qualify and low payment. Here are a few questions anyone should ask their loan agent prior to obtaining a neg am loan (also refered to as defered interest, minimum payment etc.)

1. What is the prepayment penalty on my loan? How many years is the prepayment penalty? Is the prepayment penalty HARD or SOFT? ( HARD - you must pay the penalty upon pay off of this mortgage on either a refinance of this mortgage OR upon the sale of the property. SOFT - you only pay the penalty upon refinance of that mortgage, not upon the sale of the property.)--This is VERY IMPORTANT!!

2. Ask your loan agent what they are making on the "back side". In other words how much commission (% of the loan balance) is being paid by the lender to your broker for origination on the loan. If it happens that they are making 1-2% then you should be able to negotiate no origination or reduce loan fees.

3. What is the margin on my loan? This determines your fully indexed rate each month which is tied to the current index for that month. Example: If you have a 3.5 margin you would add that to the current index for that month. (Indices include 12-COFI, 1-Month Libor, 1-Month MTA) MTA is the most popular choice because it typically offers the lowest fully indexed rate and is the least volatile.

Good Luck and be careful, Housing appreciation is not like it used to be and you should never count on it to pay off your mortgage.


Loan Guy


May 16, 2006 4:28 AM

hey Bob can you provide some contact info? i have a few questions for you. i just sold my home and am looking at the neg am loan for this very thing. thanks mike


May 18, 2006 8:30 PM

i and my wife are planning to refinance our home but we have been told that we will have to pay a prepayment penalty of about $20000. we have only had this house for six months. if we do go ahead what do you think in you opinion would be the best cause of action, because all we want to do is lower our monthly payments. we thought a neg am loan would be our best bet


May 23, 2006 6:11 PM

My fiance and I are looking to buying a home rather soon. We've been shopping around and I tell you, it's difficult enough to find the right property but actually trying to find out what type of loan we should get into is even more difficult. Everyone's is talking about this Neg Am Program. Is this really the best loan for us? No up ad down monthly mortgage every month and because we have a budget every month for the monthly mortgage. Can anyone give us any advise?

Melissa W

September 4, 2006 2:09 AM

My husband has a business and has gotten into 91,000 debt. He wants to do a neg am loan because we have a 15 yr and the monthly payment is too high he says now because of the debt. There is also a heloc (2)on our home. What should be done? 1) 342K, 2) 67 K

Peter Coy

September 6, 2006 3:44 PM

People interested in discussing the "Nightmare Mortgages" story in BW should check out the guest post by the writer of the story, Mara Der Hovanesian, which was posted Sept. 6. It's called How Toxic Is Your Mortgage? Here's a link:


November 9, 2006 4:11 PM

The MTA is for an informed buyer. That same conventional/fixed payment can be made if you choose. The diference is you pay down equity immediately when you make that payment instead of waiting ten years. Also if interest rates rise, MTA's are assumable, how many of your low fixed rate mortgages are? So anyone who has a MTA should feel smart, saavy because as long as you are a responsible person, in the not so distant future(30 years) you could do well.

Robert M.

November 15, 2006 3:23 PM

The most savvy of adjustable rate mortgage shoppers would be on a COSI or a CODI index, they historically have been the lowest. Many places tract their movement on the Internet. These are assumable as well.


November 25, 2006 1:47 AM

we are wanting to consolidate our mortgage, car payments and other bills so we can maintain a comfortable lifestyle but we were not certain when the loan agent said we could not refinance for two years without a penalty. we did not understand this at first but now we see he was making money for himself. they had already duped us for other costs as well.

Carlos Martinez

November 28, 2006 9:18 PM

There are a few factors to understand a neg am loan, I have it and I sell it to my customers
first you need to know your Marging this is very important, as per your note it tells you to add the Index to your margin. So your margin shouldn't be too high. Second what type of Index you have Libor, Mta, codi , coffi etc..some adjust less than others and more reliable also.
Third and very important is your recast some do it at 110% or 115% 125% of course you want the 125%. And finally yes PPP shouldn't be given with type of loans. But there is some good news for those who are in this loans and can't afford something better, there is now the Hybrid option arm this all the options are fixed for five years
Most of this loan will start around 7% depending on your credit. Hope this helps..

kari k

March 23, 2007 2:35 PM

Hey there,
I have a neg am loan, adj, & just fot it in dec 2006 & hate it. have tried to go through the co that put me in it, to get me out, & of course they won't. I wasn't told how neg it was, I was only showed in docs, what i would save, not where the difference went. any help? I am considering filling suit,

Neil Simmons

June 14, 2007 6:39 AM

What is NEG AM?

Negative amortization.

For those who are new buyers or not familiar with the terms used above, please read the simple explanation below.

Sometimes referred to as GEMs (Graduated Equity Mortgages) Negative amortization is used to describe loans that have payment adjustment caps instead of interest rate adjustment caps. Most loans are designed to amortize, i.e. reduce, to a zero balance by the end of their loan term. Therefore each payment contains a portion of interest (primarily interest at the beginning) and a portion of principal. These loans are referred to as "no negs" or not having the possibility for negative amortization.

How does negative amortization occur?

Negative amortization loans calculate two interest rates. The first is called the payment rate the second is the actual interest rate. The payment rate is typically capped at 7.5% of the previous payment. The true interest rate is calculated as simply the index plus the margin without periodic caps. Borrowers are given a choice of which rate to pay. Thus advertisers of negative amortization loans often refer to these loans as "payment option" loans. While it is true that the borrower has a payment option, which offers flexibility, the borrower will also be subject to the true interest rate.

Risk Considerations

The risk associated with a negative amortization product is that the interest rate calculation does not have a periodic cap and therefore can increase to the lifetime cap at any time. This is fundamentally different from "no negs" which always have periodic caps. Therefore, in terms of wealth generation, negative amortization loans are more risky and often not as good an investment as "no negs".

When to Consider a Negative Amortization Product

Negative amortization loans can be useful if the borrower is primarily concerned with cash flow rather than equity. If the borrower only pays the payment rate, the overall mortgage payment over time can be relatively low. This type of product can be a temporary strategy if income is expected to be reduced for a period of time, or if the hold period is short term to minimize cash outflow.

Nevertheless, one of the main reasons for purchasing a home is to build equity and generate greater wealth. If a borrower is primarily concerned with cash flow, a better strategy could be to simply rent rather than own.


September 19, 2007 12:25 PM

I just found out what my loan meant..that every month I am going to owe more money than when I do I get out of this. My loan matures at 4-1-08, but by the time that happens it will be exactly what I paid for the house.


January 29, 2008 10:29 AM

I'm one of millions of people in a neg am loan that was sold to me in spring '05. Just trying to by the American dream and just getting by to do it. Now almost three years later, the loan matures on 5/6/08, I owe almost $10 neg am and it will cost me approximately $30k to refinance. With an excellent credit score of 780, the only way I can see getting out of this situation without going more into debt is to go into foreclosure and then possibly bankruptcy. I was not thoroughly educated on the type of loan I was getting into along with millions of others. What would you do? Anyone have any suggestions? Thanks.

david prieto

February 6, 2008 10:26 AM

all i know is im in neg am and in 2010 im suppost to make 299 payments not 12 but 299 for that year. bought this condo for 214,000 value now is 300,000 if i make all payments total is 912,000

HELP please


April 8, 2008 3:45 PM

My wife and I got into one of these loans and it has been going up ever since. The idea when we purchased this loan was that the housing market would keep going up here in Arizona and it didn't. Then refi the house to a fixed and pay off our debt. Well, now the market has crashed, and our once 150,000 dollar house 3 years ago is now even money with what we owe on it at 300,000. Our equity has been swallowed up and things aren't getting any better. What do you do with this loan now?

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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