 Negative
amortization mortgage finances a rental
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 Dear
Dr. Don,
I want to buy an investment property in a condo conversion in Orlando,
Fla. The seller is offering incentives and financing as well. They
are offering a negative amortization loan of 1.25 percent or a fixed-rate
mortgage at 7.5 percent for 30 years. Which is better?
If I choose negative amortization, can I pay higher amounts per
month so I will not have the negative amortization? Thank you for
your answer.
-- Rose Mary Mortgagor
 Dear
Rose Mary,
With a negative amortization loan, if the monthly
payment isn't sufficient to cover that month's interest expense,
the shortfall is added to your outstanding loan balance. That's
not the end of the world if you're investing in real estate and
want to minimize your monthly cash flow while you own the property,
but there are some potential pitfalls to this type of financing.
It's likely you are being shown what's known as an
option ARM, where you have the option to make a minimum payment
that doesn't cover that month's interest expense, resulting in negative
amortization; make a payment that does cover that month's interest
expense, or make a payment that covers both the interest expense
and has a principal repayment component equal to the amortization
payment on a 15-year or 30-year mortgage.
If you chose this type of financing, make sure you
understand how the interest rate on the loan can adjust. Typically
there are interest rate caps and floors, both per rate adjustment
and over the lifetime of the loan. The quoted 1.25 percent rate
is a teaser rate for a stated number of payments, and the fully
indexed interest rate could precipitate a much higher monthly payment
-- even with negative amortization.
High levels of negative amortization might trigger
higher loan payments down the road because the lender won't let
the outstanding loan balance increase above a certain loan to value,
based on the property's appraised value. The loan will be recast
to reflect the higher loan balance and payments based on the recast
loan balance.
You haven't mentioned your credit score, credit history,
income or what size down payment you plan to make on this condo
investment, but 7.5 percent seems a bit pricey on the 30-year fixed-rate
product, and I have concerns about what the fully indexed rate is
on the adjustable-rate mortgage.
One potential problem with a condo conversion is the
resale value for these units hasn't been tested, making the potential
appreciation on these units speculative, at best. Add that risk
to the risk of a negative amortization mortgage, and you need a
lot of things to break your way in order to make this a profitable
investment.
To ask a question of Dr. Don, go to the "Ask
the Experts" page, and select one of these topics: "financing
a home," "saving & investing" or "money."
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