Mortgage won’t rise for couple

Q:My husband and I have a 10/40 interest-only loan, which means we will only pay

interest for the first 10 years. The loan amount is $265,000 and our monthly payment is $1,693.

Each month we pay an additional $105 toward principal.

Here’s my question: Is this extra amount enough to avoid being upside down on the loan if we decide to refinance?

A: A direct answer to your question is yes. Paying an extra $105 toward principal should prevent you from becoming “upside down” on your loan.

I don’t have enough information about your mortgage or property, but the nature of your question leads me to believe that you may not have a full understanding of your existing mortgage.

The term “upside down” usually means the mortgage balance is higher than the property’s market value. If your property is worth less than $265,000, you would indeed be “upside down” on your loan. I doubt if this is the case.

I think you are referring to negative amortization. This means the monthly payment made is not sufficient to cover the interest charged each month. The unpaid interest is added to the loan amount each month, resulting in a higher balance.

Your 10/40 loan means that you have an option to pay just interest for the first 10 years. This is not negative amortization because the minimum required payment covers all of the interest charged.

Making interest-only payments means that the balance never changes. After the first 10 years of the loan, your required payment would include an amortized principal and interest payment that would pay off the loan in 30 years.

The only way that you could wind up upside down on your loan is if your property value declined to below $265,000.

I don’t know what your home is worth, but if you don’t think it’s worth much more than $265,000, it might be a good idea to make extra principal payments in order to build a little equity in your home.

Your situation gives me an opportunity to speak my piece on the difference between interest-only loans and negative amortization loans.

The press often puts these two mortgage products in the same pot and often depicts them as irresponsible and dangerous. In fact, these programs are very different.

On loans that allow negative amortization, unscrupulous lenders tout a low “payment rate” that misleads borrowers into thinking that the actual interest rate is the payment rate. The payment rate might be 3 percent, for example, while the actual interest rate is 7.50 percent. The unpaid interest is added to the principal balance each month.

If the property was purchased with a low down payment, it may not take long for the mortgage balance to exceed the property value, especially during a period of flat home values.

The other very big problem with loans that allow negative amortization is that most carry monthly adjustable rates. Even if the borrower chooses to pay only interest to avoid the negative amortization, he is still not protected from the possibility of rising interest rates.

While monthly adjustables were carrying fully indexed rates as low as 3 percent a few years ago, most are now pushing 8 percent.

To compare these programs with loans that allow interest-only payments, but not negative amortization, is flat wrong for two important reasons.

The first is obvious. The mortgage balance can never increase.

Second, and more important, interest-only loans are widely available with a fixed-rate period, usually five, seven or 10 years. In fact, there are interest-only loans that carry a fixed rate for the full 30-year term. This eliminates any interest-rate risk for the borrower.

One last comment: You did not specify the interest rate on your loan but indicated that your payment is $1,693 per month. With a balance of $265,000, my calculator tells me that your interest rate is something close to 7.625 percent.

If this is correct, you should consider refinancing to a lower rate because market rates for zero-closing-cost refinancing are significantly lower. If the $1,693 includes the escrow amount for taxes and insurance, your interest rate would be lower.

Henry Savage is President of PMC Mortgage in Alexandria. Reach him by e-mail (henrysavage@ pmcmortgage.com).