By Trish Signet, Loan Officer, Summit Mortgage

With interest rates rising steadily over the last few years, it's become somewhat harder for property investors and others to make the numbers work.

For example, that same rental property whose tenant-generated cash flow may have covered all of the monthly mortgage burden as recently as three years ago, may no longer be self-supporting. Higher rates mean higher mortgage payments, and the differential can often squeeze cash-flow-strapped investors out of the market.

Negative amortization mortgages can help... but beware, with the significant benefits come equally significant risks.

First, let's make sure we understand the concept. Fannie Mae defines negative amortization as follows: "An increase in the balance of a loan caused by adding unpaid interest to the loan balance; this occurs when the payment does not cover the interest due."

This Article is an excerpt from the 16 Page Print Edition!

Are YOU getting the print edition of ForeclosuresMass Monthly?

Get a FREE copy* of this month's newsletter (worth $49.97!) when you pickup your Real Estate Investors ONLY Free Gift (worth over $267.97!)

First Name:

Email Address:

* Next 37 17 investors only!

In other words, rather than paying a piece of the interest and principal each month as occurs with a typical mortgage, with negative amortization, the borrower pays no interest and (typically) only part of the principal with each payment. The part that isn't paid each month gets added back on top of the original loan amount. Since amortization means "paying back," a loan in which the amount owed grows each month is a "negative amortization loan."

Naturally, there are advantages to this type of arrangement:

1. Lower monthly payments. Since you are not paying the full interest due, and often only some of the principal, your cash flow is better.

   For example, on a $300,000 mortgage, with a 30 year fixed rate of 6.50%, the fully amortizing principal and interest payment would be $1,896 per month. On a negative amortization loan of the same amount on the other hand, the minimum monthly payment could be as low as $1,035! A huge difference, amounting to over $10,000 per year in total payment savings.

2. Payment flexibility. Many negative amortization programs offer the choice of paying the fully amortized payment, the minimum payment, or an interest only payment each month. That flexibility can of course be helpful, particularly if you find yourself temporarily without a tenant, or if an unexpected - but urgent - property expense suddenly arises. When these short term emergencies are taken care of, you can go back to making full payments.

3. Interest deferral as a tax strategy. Since interest payments are recognized in the year that they are paid, some investors deliberately try to match these payments with income recognition which may not occur until a later time. The ability to defer interest payments under a negative amortization loan may allow an investor to better manage the tax implications of investment property ownership (check with your accountant on this one, since the specifics will vary).

Those are the advantages. As mentioned earlier however, there are disadvantages as well with this approach:

1. Instead of building equity, you may be losing equity. With a standard mortgage, your monthly payments reduce the size of your debt. Month after month, year after year, if you keep paying the full amortization amount over the term of the loan it will eventually drop to zero.

   With negative amortization however, you're not reducing the size of your debt each month, you're adding to it. Combine that with the drop in real estate values that we've seen recently, and you could easily find yourself holding a mortgage in excess of the value of the property itself! At that point, if you want or need to sell the property, the loan you need to pay off would be higher than the amount of cash generated by a sale. Under these circumstances, you would literally have to raise cash from another source simply to get out from under the property.

2. Negative amortization specifics can be confusing. To many people, the terms "negative amortization" and "interest only" are very unfamiliar. In addition, the various payment options can make planning for and paying your mortgage on a monthly basis more complicated than you may like. A negative amortization loan requires more work on the part of the borrower, and requires a greater amount of education regarding the program being signed on to.

3. Too much flexibility. Flexibility cuts both ways, and while it's nice to have the option of choosing a lower payment on a month by month basis when necessary, it can be a very slippery slope. Unless you are naturally well disciplined - so that you make the complete payment and only drop to a lower level when needed - you run the risk of never digging out from under your mortgage debt.

Negative amortization, like many other creative lending options newly available in recent years, allows many investors to get in the game, who previously might have had to sit on the sidelines. Buyer beware however... with these new opportunities come new risks as well.

Trish Signet, Loan Officer, Summit Mortgage. With over 10 years experience in the mortgage business, Trish works with each and every client to identify the mortgage financing options that are best suited for both their short and long term financial goals. She may be reached at 781-541-6410, tsignet@summitmortgage.com or online at Summit Mortgage.

Limited Liability Companies (LLCs) «

June 2006

Interview with the Experts »

Did you like this article? You May Also Like:

	Agent Success: Pulling The Trigger: Do You Have What it Takes? Kevin Norton Getting involved in the foreclosure market can reap great rewards, as long as you take the time you need for study, research and observation. The more you know in any business - especially foreclosures - the more success you'll enjoy...
	Nothing Succeeds Like Success: Jennifer Wilson Jennifer Wilson In just 4 short years, Jennifer Wilson has grown her real estate investment practice from a standing start to one which expects to buy and sell 25 properties in 2006. ForeclosuresMass sat down with Jennifer to understand what's worked - and what hasn't - in her quick rise to the top!
	Interview With The Expert: Managing "Bad" Credit Marty Eerhart, Senior Loan officer, Assured Mortgage Getting the approval needed for an investment loan is heavily dependent on your credit score. Unfortunately, if you have "bad" credit, it can get in the way of making a purchase. Marty Eerhart talks about what you can (and can not) do to improve your credit score.
	Legal Spotlight: Think Title Insurance Is a Waste of Money? Think Again! Jason Kane, Esq. You may have heard title insurance isn't available for foreclosed properties or that it's an "optional" (read: unnecessary) expenditure. Yet, as Jason Kane explains, title insurance protects your investment from undisclosed liens and fraud - and can save you from literally losing the shirt off your back.
	Nothing Succeeds Like Success: Gail McCarthy Powers Her Way to Profits Gail McCarthy A real estate investor since 2004, Gail McCarthy recently completed two deals in Alabama for 100+ unit apartment buildings. She talks about her personal journey and how she’s been able to leverage her experience investing in single-family homes into a new career in commercial real estate.
	Feature Article: Five Strategies for Successful Long-Distance Real Estate Investing Holly Daigle Yes, buying properties in other states can be a logistical nightmare – especially when you need a team of real estate experts for each state in which you do business. Real estate investor Holly Daigle explains how to develop foolproof processes for keeping everyone in the loop and why it’s essential you build a network of people you absolutely trust.
	Feature Article: How Green Light Realty Exploded Profits by Documenting Business Systems Don Armstong, Green Light Realty Working with E-myth coach David Hilton, Don Armstrong put in place documented systems that has helped him run his business more efficiently, lower his costs, generate more leads - and close short sales 93% of the time. Don takes you inside the experience of working with a professional coach and explains three of the steps he took to transform his business.
	Finance Corner: A Good Fit: Real Estate in Your Investment Portfolio Christopher P. Gullotti, MSFP Financial planners hear comments about real estate investments frequently. Does investing in real estate truly offer financial opportunities? Many times yes, but not always for the reasons people think...
	Success Strategies: Seven Traits of Highly Effective Investors James A. Gage We all know about the late night talk show gurus who promise you can become a millionaire overnight. Yet, as James Gage explains, successful investors practice seven traits most "gurus" don't talk about. Read his article to learn how you can turbo-charge your investing business - and go to sleep earlier at night.
	Feature Article: Three Steps to Rebuilding Your Credit After Foreclosure Stephen R. Elias, Attorney Gone are the days when rebuilding one's credit history after going through bankruptcy or foreclosure was straightforward. With the crash of the sub-prime lending market, consumers are under intense scrutiny when applying for mortgages and credit cards, which means rebuilding credit can now take three to five years - or longer!. In his article, bankruptcy attorney and author Stephen R. Elias provides three key steps that you can pass on to your clients who need advice on how to recover from foreclosure.