Luke Ford

A source says: A financial scandal is brewing that the LA Times, as usual, is slow to pick up. It goes like this. When you have an adjustable rate mortgage, your payment is initially fixed, let’s say at $2500 a month. When rates go up, your monthly payment goes up. However, all of these "ARMs" (adjustable rate mortgages") allow you to keep paying the base payment of $2,500 and add the increased payment to your principal balance. This is known as "negative amortization" – instead of amortizing your loan down, you are adding to the balance.

Since rates have gone up, lots of borrowers have been allowing negative amortization to occur, and now, their principal balances are in excess of their homes’ value. For instance, borrower buys a home for $400,000 and borrows $320,000. His monthly payment is about $1700 a month. Rates have gone up the past few years, and the payment has been running closer to $2000 a month. Over three years of this increased payments, the borrower has added about $15,000 to his mortgage balance (the $300 a month in extra payment not made per month, multiplied by 3-4 years). Now the mortgage balance is $335,000 and if the buyer took out a home equity line of say, $40,000, the total loan balance on the property is $375,000 ($320,000 original loan, $15,000 negative amortization, and $40,000 home equity loan).

As you know, prices are down in some areas by 20-30% and falling further as the market softens. So now the $400,000 house is only worth $320,000 and the borrower is upside down. The bank’s loan of $320,000, now up to $335,000 looks to be in jeopardy, and people are advising buyers to just walk away or give the bank back the house for $320,000. But THAT IS NOT HOW THE BANK IS REPORTING IT. Instead, banks like First Federal, Downey Savings, Washington Mutual (they are mortgage lenders more than banks, they are heavily invested in real estate), are including negative amortization, which is a classic doubtful account, as earnings. Somehow, an increased IOU from a shaky borrower, is income. The whole negative amortization thing is is like giving crack to an addict.

So many local area banks have this negative amortization that the LA Times should be sending its reporters out, but of course that will not happen. You can read about negative amortization on some blogs and in business week, but not at the LA Times.

From the July 29, 2007 edition of the Los Angeles Times, the column by Robert J. Bruss:

Question:When my adjustable-rate mortgage was recently "recast" to current interest rates, the unpaid interest was added to the mortgage principal balance. I now owe about 110% of my home’s market value. I recently lost my job. Do I have any recourse to convince the mortgage lender to do the right thing?

Answer: You enjoyed the low monthly mortgage payments for a year or two after obtaining that mortgage. When the mortgage terms provided for a "recast" to a higher interest rate and larger monthly payment, the lender added the unpaid interest to your mortgage balance. This is called "negative amortization" because you owe more than you borrowed.

If you are unable to make the higher mortgage payments, ask your lender if you can sell the house for its current market value as payment in full on the mortgage. This is called a "short sale."

Most lenders will approve a short sale only if you are behind in monthly mortgage payments with little hope for catching up.