- The Washington Times - Wednesday, February 9, 2005

Let’s continue our discussion of flexible-payment mortgage plans, which have gained

considerable popularity during the past couple of years.

In response to consumer demand, lenders are offering mortgage programs that allow the borrower to choose how much his payment will be in any given month. To recap, there are typically four payment options:

• Minimum payment. The lowest payment option is usually less than the interest charged, resulting in negative amortization.

• Interest only. This payment covers the interest charged during the month but excludes any principal curtailment.

• 30-year amortization. This payment is based on a 30-year payoff period.

• 15-year amortization. This payment is based on a 15-year payoff.

I want to focus on the minimum-payment option. The other payment options are self-explanatory.

There’s a lot of misleading and inaccurate information out there, and I’m going to try to set the record straight.

First, understand that negative amortization, or “deferred interest,” means that the mortgage balance increases every month because the payment doesn’t cover the interest. This is not necessarily a bad thing, as some critics charge, as long as the borrower understands the program and knows what he’s doing. Simply put, a so-called “neg am” loan increases overall debt to allow for a super-low monthly payment.

The problem I have is how some of these programs are advertised. On the radio last week, I heard a mortgage company’s advertisement that touted an “interest-only” payment. The speaker said words to the effect of: “Our interest-only mortgage allows you to trim your mortgage.”

That’s baloney. How can a payment that doesn’t curtail principal “trim” a mortgage? It can certainly lower a borrower’s monthly payment, but the balance doesn’t budge.

Now let’s talk about negative amortization. The minimum payment on these “flex-pay” mortgages is usually based on some predetermined calculation.

Here’s an example: The minimum payment might be based on a 30-year amortization with an interest rate of 1 percent. On a $300,000 loan, that payment would be $965 per month. The “1 percent” should be referred to as the “payment rate” because you can bet your bottom dollar that it’s not the true interest rate of the loan.

Let’s take it a step further.

This loan carries an adjustable rate tied to a popular index, the Monthly Treasury Average, currently yielding 2 percent. The loan carries a margin of 2.50 percent over the index, creating a fully indexed rate of 4.50 percent. This is the actual interest rate on the loan.

In order to avoid negative amortization, the borrower would have to make a payment that’s enough to cover the interest charged at 4.50 percent. My calculator tells me that the interest-only payment is $1,125.

But the minimum payment is only $965. If the borrower makes the minimum payment, the difference would be added to mortgage balance, increasing it to $300,160.

As I said, this is fine as long as the borrower is aware of what’s going on. The problem is that many borrowers mistake the “payment rate” with the actual interest rate.

It doesn’t surprise me. I’ve heard radio ads and seen newspaper ads that tout “rates as low as 1 percent.”

Well, that’s baloney, too, as you now know.

The bottom line: If something looks or sounds too good to be true, it very well might be.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]).

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