Negative amortization is a bad idea
|  Dear
Dr. Don,
I am thinking of refinancing to pay off credit card debt,
but I live in Texas and my loan-to-value ratio is too high to get cash out. I
have been offered what is basically a negative amortization loan, a five- or seven-year
ARM where the rate is locked in. If I take the minimum payment option I can use
the extra money each month to pay off credit cards but I am worried about how
much I will be adding to the back of the mortgage loan.
We
will be looking to move within five years, but have been told that it will be
no problem to refinance after, say, two years when hopefully all the card debt
will be repaid.
The company offering this loan has told me that I
will add back about $9,000 to the loan over a two-year period, but
I will save thousands in credit card interest. It seems to me that
this is just like a cash-out refinance but you don't get the cash
all at once. Our credit is "fair," we have about $25,000
of equity in the property and owe about $12,000 on our credit cards. Should
I go for it?
-- Lynne Loan
 Dear
Lynne,
Replacing credit card debt with mortgage debt doesn't pay off your
credit cards; it just restructures your finances. According
to Bankrate's 2006 closing
cost survey, the average cost of refinancing a first mortgage
is $3,024. You're considering doing that twice in two years. Paying
$6,048 to restructure $12,000 in credit card debt isn't going to
save you money. Would you pay six grand to refinance 12 grand?
I wouldn't.
Negative amortization
exists when your monthly mortgage payment isn't big enough to cover the interest
expense. The shortfall gets added to your loan balance. Instead of paying
down the loan, your loan balance increases with time. The loan
agreement is likely to stipulate that the minimum monthly payment gets recalculated
if the loan balance increases by a certain percentage over the initial mortgage
amount. When that happens the money you thought you had freed up in your monthly
budget isn't there anymore. The Federal Reserve Board publication, "Interest-Only
Mortgage Payments and Payment-Option ARMs,"
discusses this risk in greater depth.
If you think being upside down in a car is rough,
try being upside down in a house. With $25,000 in equity, a
plan to tap $12,000 of that to restructure your credit card debt
doesn't leave much room for a downdraft in housing prices or a real
estate commission check if you had to sell.
Chip away at the outstanding credit card balances
and stop looking to your home's equity to save you from spending
more than you make. The Bankrate calculator, "What
will it take to pay off my credit card?," can help you
map out a strategy to pay it down.
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."
| 
