Choosing an ARM with negative amortization?

Avoid these risks
Thursday, May 18, 2000

By Julie Clairmont
Inman News Features 

Mistake: Falling for 125 percent home equity loans

Most often obtained to consolidate credit card debt, these loans convert unsecured credit card debt to mortgage debt, which means if you don't make payments the bank can foreclose on your home-a bad risk say the Mortgages for Dummies authors.

Also, they add, many consumers will simply go out and run up the same credit card account balances, and end up in even worse financial shape.

However, some lending experts, including Rick Olson, president of Diablo Funding Inc., say this type of loan could be useful if a person were using the home equity loan to remodel their home, and knew the home would be worth enough when the work was finished to make the loan sensible.

“If you're using the loan to create equity, that is a different story, and I have seen that work many times,” says Olson.

But if the loan is being used to pay off credit card debt, it's probably a bad idea, he agrees: "The only way that would be helpful, is if you could discipline yourself to never use your credit cards again. But how likely is that to happen?"

Mistake: Choosing an ARM with negative amortization?

“Negative amortization has the potential to be a personal financial neutron bomb. It destroys the borrower without harming the property. If you're offered an ARM with negative amortization, emphatically say: NO!” ? - Mortgages for Dummies.

Not necessarily the case, Olson said. However the caveat, he says, is that the negative amortization loan must be tied to a historically slow moving index such as the Cost of Funds Index (COFI) or the Cost of Savings Index (COSI).

Negative Amortization is also referred to as “deferred interest,” because the monthly payment on these types of loans is not large enough to cover the loan's interest charges, so the balance of your loan actually grows.

Olson points out that some of these loans are actually good, because the borrower has the option to pay a lower payment when he can afford to, and pay more when he can afford to.