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Definition: Negative Amortization Limit
There might be cases where the monthly interest payments are not paid completely i.e. only a part of the amount is paid each installment. Therefore, the balance amount gets added to the principal balance. This process is known as Negative Amortization the value that can be added to the principal balance is limited. This limit is known as the Negative Amortization Limit. This provision is applicable to specific loans only.
Consider the example of Mr. X who has taken a loan of $ 10, 000 at 5% interest per year. The payments would come up to $ 53.68 per month and has to make 360 (= 30*12) such payments. If the person pays only $ 5 per month, then the additional $ 45 would be added to the principal balance.
Also, let the negative amortization limit be 103%. This means that Mr. X can defer the payment or partially pay the interest payment till 103% of Principal Balance i.e. $ 10, 300. The amortization schedule would therefore show that after 9 months, the negative amortization limit is exceeded therefore; a new amortization schedule is designed.
• Though many mortgages include the “Negative Amortization Limit”, this option would only cause more loan problems because deferring payment would only result in a higher loan balance and greater interest to be paid.
• Profitable to investors who cannot afford such high payments initially but are expecting larger incomes later on
• This limit prevents loan from spiraling out of control