These "PayOption ARM" loans quite frankly shouldn't have been legal, and if they were, they shouldn't have been made because nobody should have been stupid enough to buy the debt.
They allowed the sucker (or mortgage fraudster) to pay no principal, and less interest than what was due. And every month the idiot didn't pay up, the balance grew and grew and grew some more. What a deal! Until house prices crashed, and now nearly every one of these loans will go bad as the debtors simply walk away.
And just to make this "innovative financial product" one of the worst financial products ever invented, GAAP allowed the holding bank to recognize the shortfall in what was owed every month as NONCASH INTEREST INCOME.
You got it folks, when the homedebtor didn't pay the amount due, the bank could recognize the shortfall not as bad debt, but as FU*KING INCOME, making the banks who held the cancer look good (for awhile) and their management earned massive bonuses.
Yes, the world went mad. And now we all pay the price.
HP'er Extra Credit - go do some digging around and see what banks are holding this cancer. I saw reports that WaMu had $67 billion of these turds and Countrywide had $35 billion - and of course were recognizing income for the payment shortfalls. I'd like to know where banks stand today. And invest accordingly!
In finance, negative amortization, also known as NegAm, occurs whenever the loan payment for any periodic is less than the interest charged over that period so that the outstanding balance of the loan increases. As an amortization method the shorted amount (difference between interest and repayment) is then added to the total amount owed to the lender.
Accounting For Negative Amortization
Accounting for negative amortization is a perennial favorite amongst those who follow banks and thrifts with large Option ARM portfolios. It outrages a lot of folks that the neg am balances, which represent interest that has been earned but not paid, is considered noncash interest income.