- The Washington Times - Wednesday, June 28, 2006

Q:I’ve been reading your columns about loans with negative amortization with

interest. My son might be in a bind, thanks to the slowing market. He has contracted to purchase a newly built home and is scheduled to settle in mid-July.

He has not sold his current residence, which is on the market for $800,000.

Would you recommend that he take out a loan with negative amortization to keep the payments down since he will have a double mortgage for an unknown period of time?

A: Let’s recap. An Option ARM is a loan that allows a very low minimum payment, resulting in negative amortization, or “neg am.” Neg am occurs when the minimum payment doesn’t cover the interest charged, increasing the balance of the loan. While these loans can be a good deal when short-term interest rates are low, they are not such good deals when short-term rates are high, as they are now.

You have touched on an interesting aspect. An Option ARM may allow a payment rate of 1.25 percent, but the actual interest rate might be as high as 8 percent. Since fixed rates are currently about 1 percent lower than the interest rates on Option ARMs, there are not many circumstances where I would recommend an Option ARM. Short-term rates would need to fall considerably before Option ARMs are back in favor.

It appears that your son has put himself in a bind. When the market was red hot, sellers were not accepting any offers with a contingency that another house be sold. Thanks to the red-hot market, buyers who needed to sell their existing home had no problem doing so. But all markets eventually balance out, and now your son is obligated to purchase the new home regardless of whether he sells his existing home. Indeed, if he doesn’t sell the home, he will be paying two mortgages.

An Option ARM allows the lowest monthly payment of all the mortgage products available, but the negative amortization can be hefty. The mortgage balance can increase as much as $350 per month for every $100,000 that’s borrowed. The neg am on a $500,000 loan for example, can be as much as $1,750 per month.

I don’t have enough information to make a firm recommendation as to whether your son should take out an Option ARM, but I can suggest some things he needs to consider.

How much of a down payment can he make without selling his current residence? Perhaps a smaller down payment will free some cash to carry both mortgages for a while.

How long has his current residence been on the market? He should examine the feasibility of reducing the price in order to encourage a quick sale.

Can his residence be rented easily? Perhaps renting the house for a year or two is a viable alternative.

Noncontingent offers are standard when the market favors sellers. But if, for some reason, a buyer is unable to sell his house while committed to buying another one, he must have a backup plan. A good loan officer should be able to provide some alternatives.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavagepmcmortgage.com).

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