What is Negative Amortization?
Negative Amortization is a method of repaying a loan with regular payments. It means that even while you are making minimum payments, you are not paying any interest on your loan. Therefore, the amount you owe goes up.
When a leading financial institution like Bajaj Finserv offers you this convenience, they add the unpaid interest to the amount you borrowed. When you make a payment which does not include the interest charged at the time, you create a deferred interest. The amount of deferred interest created is then added to the principal balance of the loan which leads to a situation where the principal owed increases over time instead of decreasing. This is the basic concept of negative amortization definition.
Negative amortization is one of those amortization types that does not continue indefinitely. At some point of time during the loan tenure, the amount must start to amortize over its remaining term. Typically, loans that amortize negatively have scheduled dates when the payments are recalculated, so that the loan amount will rather hold a negative amortization limit or will amortize over the balance tenure. This means that when the principal balance of the loan reaches a certain contractual limit, the payments will be calculated again. The tenure for this loan is constant with either the principal amount or the interest rate allowed to change.
Negative Amortization Cap:
There could be a time that you reach the cap limit of this loan. It is the maximum amount of the principal that the loaner can reach. For example, if a person borrows a loans of Rs. 1,00,000 with a negative amortization cap of 120%, the maximum amount the principal can reach is Rs. 1,20,000.
Negative Amortized Loan Example:
Consider this example of negative amortization loans wherein the loan comes with an 8% annual interest rate, a remaining principal balance of Rs. 1,00,000, and a provision that allows the borrower to make Rs. 1000 payments at a certain number of scheduled dates of payment. The loan’s due interest of the following payment would be: 0.08 / 12 x 1,00,000 = Rs. 666.67. If the borrower makes a payment of Rs. 1000, then he incurs Rs. 166.67 in deferred interest (Rs. 1166.67 – Rs. 1000). This will be added to the principal balance of the loan for a total remaining principal balance of Rs. 100,166.67. The following month’s interest charge would be based on this new pending principal amount and the continued calculation for the dates scheduled for the repayment.
For this loan, if the negative cap is 120%, then the amount can go on increasing to Rs. 1,20,000 without the client being defaulted. The amount cannot go above this limit, and the repayer has to make sure the amount is repaid through the monthly installments. Amortization can be through either the principal amount (as is the case in the above example) or on the interest rate. Either way, the time period of repaying the loan remains constant.
Good lenders such as Bajaj Finserv provide a moratorium period for this type of a loan. Bajaj Finserv provides facilities such as ‘3 EMI Holiday’, wherein they give you the option to skip the first three EMI’s, in order to make repayment easier.
Therefore, while taking a long term loan, do try to get as much information as possible and ensure that your lender is a consumer friendly lending institution.