What is “Neg Am?”
Neg Am is short for “negative amortization.” So, what is negative amortization? As the name implies, it’s not a good thing. If you are making payments on a loan and you are not covering the interest accrued for the prior month, your loan balance will be ever increasing. Any interest not paid for the prior period will be added to the principal.
For example, let’s say you owe $10,000 and your monthly payment to pay off the loan in ten years is $500. Part of your payment would apply to the principal and part of it would apply to the interest. For ease, let’s say $300 applies to principal and $200 applies to interest. If you are only making payments of $100, then $100 would be added to the principal. Why? You have only paid $100 of the $200 due in interest. Next month you would owe $10,200.
It gets worse. Now, your required payment for the next month to pay down the loan will be, for example, $510, due to the interest accumulated from the underpayment last month. If you only pay $100 the next month, the following month you will owe $10,450. This will continue on, forever, or until you increase your payment amount to cover interest AND some principal.
If you let this go on, your balance will go to infinity. Of course, you will die before that happens, but you get the point.
Why would my lender allow me to make Neg Am payments?
There are many reasons. But it really boils down to this. All lenders should want their loans to be repaid. (Yrefy is a lender – that’s what we want). However, all a lender must ultimately do is cover their cost of funds (what rate they pay times the amount they’ve borrowed), cost to service your loan, and some profit. What does this mean? Most, if not all, lenders borrow the money they lend. Really? Yes, it’s true. Obviously lenders borrower at a lower interest rate than they charge you. This is why banks or any lender, exists.
Believe it or not, many lenders borrow at ridiculously low rates. This is especially true of very large banks.
So, if the payment you are making covers the interest they pay, the cost to send statements to you, plus some profit (spread) – all is well. In fact, all is great from their perspective. Your balance is going up, up … up! Someday you may actually pay them back, but in the mean time they have a very nice income stream from you.
I’m making payments, although less than what they should be. My lender says I’m current but my credit score keeps dropping. Why?
First read the Neg Am FAQ’s. Now, the short answer is your lender is reporting you to the credit bureaus as “in delinquency or default.” Really? Yep. Why would they do that? They like you positioned right where they’ve got you. Can you get another loan with your credit in its current hammered state? Of course not! This does two things for them. First, you cannot get any deeper into debt, of any sort. So, your money goes to paying them. Second, no other student loan refinance lender will touch you (Yrefy, excluded). This protects your loan from being refinanced out from underneath them. (Have you tried going to SoFi, or any of the other student loan refinance companies? We are pretty confident you were flatly rejected.)
I think I’m in default on my loan. My lender says my interest rate is only 4% (or some other unrealistically low number for a defaulted loan). Is this true?
It may be, but it is highly unlikely the effective rate you are paying is anything close to that. It’s our experience, most delinquent or defaulted borrowers are paying an effective rate of somewhere around 14%. Why? When you consider all of the collection costs and late fees, any period(s) of negative amortization during your repayment, plus the original contracted interest rate, your effective interest rate will be much higher – probably around the 14% mark.