The Truth About Negative Amortization

Bruss is away. These questions are taken from previous columns.

Q: DEAR BOB: About a year ago, we bought our home with the help of an adjustable-rate mortgage at 1.95 percent interest. We knew it would adjust after six months to 4.95 percent. That was quite a jump in our monthly payment, but we handled it. However, when we received the lender's Internal Revenue Service 1098 year-end report, we learned our mortgage balance had grown by about $7,800. When I called the lender, I was told the increase was "unpaid interest." What's that? -- Jerry G.

A: DEAR JERRY: The lender should have explained that the 1.95 percent "teaser" interest rate and your current 4.95 percent interest rate don't fully pay the ARM interest rate, which probably adjusts monthly. The unpaid interest you didn't have to pay was added to your mortgage's principal balance each month.

This is called "negative amortization" because you aren't paying the full amount of interest owed to the lender.

The result is that you are not building equity by reducing the mortgage balance, which is growing each month instead of slowly declining as with an amortized mortgage.

Hopefully, your home's market value appreciates faster than your mortgage balance increases. Now you know why I never recommend negative-amortization ARMs.

DEAR BOB: My husband and I have a life estate in a 60-year-old house. We can live in it until we both die. However, the house is not in good condition. It has dry rot, mold and an ant infestation. If I survive my husband, could my husband's daughter have me thrown out for "waste," as you described in a recent column? My husband's family is nice enough to me now, but things could change if he dies first. -- Nancy H.

DEAR NANCY: If the remainderman (your husband's daughter) becomes alarmed at the lack of maintenance of the house, which she will possess after you both die, she can bring a lawsuit for "waste" to terminate the life estate. It is then up to the court to determine whether the life tenant is allowing the house to badly deteriorate and if the life estate should therefore be terminated.

Avoid discussing the condition of the house with the daughter, and do your best to maintain it.

DEAR BOB: My wife and I, in our 70s, are considering a reverse mortgage. We own a free-and-clear condo worth about $500,000. However, it is in a small complex of only three units. We have been told that our unit won't qualify for a reverse mortgage. Is this true? -- Gene B.

DEAR GENE: Consult a representative who handles FHA, Fannie Mae and Financial Freedom Plan reverse mortgages to see whether your situation qualifies with any of these lenders. Generally, Financial Freedom Plan is the most flexible. The best place to find local reverse-mortgage originators is http://www.reversemortgage.org.

DEAR BOB: My fiance and I both own homes. We want to sell his, after meeting the 24-month requirement for ownership and occupancy to qualify for the $500,000 tax exemption. He has lived there about 10 years. Other than being married in the year of the sale, how do I prove two years of occupancy? Must I live there full time? After the two years are over, I would like to move back into my own home. My certified public accountant says I don't have to live there at all. We need the full $500,000 exemption. -- Bonnie T.