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Negative about negative amortization loans

Dr. Don TaylorDear Dr. Don,
I am retired, have a lot of equity in my home and believe a negative amortization loan will help me with cash flow, especially in a weak economy with interest rates so low. I have been talking with a mortgage broker who offers such a loan on a $500,000 refinance based on the MTA (Monthly Treasury Average) one-month ARM (adjustable-rate mortgage).

The rate of 1.95 percent is said to be the rate I would pay each month for 30 years. Month to month changes in the rate would, if upward, be negatively amortized. At 1.95 percent, the quoted payment is $812. I received a good faith estimate from a California bank, signed it and mailed it. Then I learned from the broker that the loan data was wrong. Instead I was asked to go with a larger bank that supposedly offers the same loan.

At one point I was told the loan was through Fannie Mae. At another time I was told I couldn't learn the name of the lender for competitive reasons. My questions: (1) Does any of this make sense? The broker insists the loan is valid and that she has over 20 years' experience working with a large bank. (2) What should I get in writing from her before I hand $350 to an appraiser? (3) Who offers Fannie Mae mortgage products in Orange County, Calif.? -- Jim

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Dear Jim,
You've given me a lot of information about this mortgage loan that you're interested in, but nothing about your finances other than you need help with cash flow. If you're looking to tap the equity in your home with no real prospect of paying down or paying off the loan balance, then you should also consider a reverse mortgage. Fannie Mae provides a guide to this type of mortgage that will give you enough information to help you decide if this is the right product for you.

My best advice, however, is that you hire a fee-based financial planner for a few hours to review your finances and establish what you need to accomplish financially, both with the refinancing and with the other aspects of your finances. The National Association of Personal Financial Advisors can help you find a professional in your area.

I can think of a lot better ways to tap the equity in your home than signing up for a negative amortization loan. For readers not familiar with negative amortization: When the interest rate resets to a higher rate with a negative amortization ARM, the mortgage payment doesn't change. Instead, the additional interest expense is added to the loan balance.

The increased loan balance makes for higher interest expense, escalating the problem and the loan balance over time. They're called negative amortization loans because the loan balance increases over time.

There's not much room for interest rates to go lower, so increasing interest rates over time will raise the loan balance (negative amortization) while your monthly payment remains unchanged, at least initially. The $812 a month you quote in your letter represents an interest-only payment, so until the loan starts to amortize, there isn't a principal component to your monthly payment. It may help with cash flow, but it won't do anything toward paying off the note.

Mortgage brokers don't want you to pick their brains and then drop them to go to the lender that offers the product you want. That could be the reason your broker is being coy about who is offering the loan.

Originating lenders gain funding by selling mortgages designed to become part of a pool of mortgages that will be sold by Fannie Mae. Fannie Mae's Web site allows you to find a lender in your state. California has 166 listings, so it shouldn't be hard to find a few doing business in Orange County.

The Monthly Treasury Average, courtesy of Bankrate's leading rates definitions, is "an index determined by the monthly average of one-year Treasury bills. It's an index that is used to set the cost of various variable-rate loans, particularly adjustable-rate mortgages. Lenders use such an index, which varies, to adjust interest rates as economic conditions change. They then add a certain number of percentage points called a margin, which doesn't vary, to the index to establish the interest rate you must pay. When this index goes up, interest rates on any loans tied to it also go up. Its use as a loan index is relatively new. The MTA generally fluctuates more than the 11th District cost-of-funds index, although they track each other closely."

You can track the MTA using Bankrate's Rate Watch feature.

Finally, you don't want to pay for an appraisal unless you're certain that the lender will accept that appraisal. So, you have to have the lender lined up before you start hiring an appraiser.

-- Posted: Oct. 21, 2003




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