I will be up front.  I dislike negative amortization loans.  They are only to be used by sophisticated borrowers.  Don't use them if you do not fully understand the loan.  Many borrowers used them to refinance their Metro Detroit homes or to buy their Michigan homes.

Negative amortization loans are also called pic-a-payment loans, option arm loans, option payment loans or smart loans.

The bank or lenders offers a loan at a very low introductory rate.  For years option arms were at 1% or 1.99% introductory rate.  Depending on the bank the introductory rate lasted from 1 to 3 years.  But here is the catch the 1% is not the real rate.  That is just an introductory rate.  The actual rate is much higher.  Usually the actual rate is higher than a 30 year fixed rate.  So a 1% introductory rate option arm may have an actual rate of 7%.

So how an option arm works is that you have 4 choices each month you make a payment.  You make the low introductory rate (1%) payment, or a interest only payment (7%), or a 15 year payment (7%), or a 30 year rate payment (7%).

If you make the 1% payment the other 7% -1% = 6% goes on the back of the mortgage.  So if you have a $400,000 loan and you pay the minimum payment of 1% for the whole year you only pay $4000 in interest for the year.  The other 6% gets added to the back of the loan.  So now the borrower owes $420,000.  That is why they call it a negative amortization loan.

The problem with the option arem loan or negative amortization loan is that many loan officers never fully explained the loan.  It was sold as an inexpensive loan.  Many times borrowers bought Metro Detroit homes that they really could not afford.  They were banking on the Metro Detroit Michigan homes appreciating more that the balance that was being added on the back of the loan.  When Metro Detroit home prices fell it had disastrous results for many homeowners in Michigan and many home across the country.

One more thing that is did not discuss is that the actual rate is not a fixed rate.  It is a variable rate that is based on a variety of different indexes depending on the bank that offered it.  So your payment or the amount added to the back of the loan could go up or down.

So if you are thinking of buying a Metro Detroit home and a loan officer offers you a Option arm so you can afford it.   Run, if you can't afford a 30 year fixed rate you can't afford that Metro Detroit home.  Be a smart home buyer.  Don't buy more home than you can afford in monthly payments