This approach enables you to lock in the purchase price. You can also use this method to "buy time" in the hope that interest rates will decrease. From the seller's perspective, this plan may provide the buyer time to obtain sufficient cash or acceptable financing to proceed with a purchase that may not be possible otherwise.

Reverse Annuity Mortgage If you already own your home and need to obtain cash, you might consider the reverse annuity mortgage (RAM) or "equity conversion." In this plan, you obtain a loan in the form of monthly payments over an extended period of time, using your property as collateral. When the loan comes due, you repay both the principal and interest. A RAM is not a mortgage in the conventional sense. You can't obtain a RAM until you have paid off your original mortgage. Suppose you own your home and you need a source of money. You could draw up a contract with a lender that enables you to borrow a given amount each month until you've reached a maximum of, for example, $10,000. At the end of the term, you must repay the loan. But remember, if you do not have the cash available to repay the loan plus interest, you will have to sell the property or take out a new loan.

LOSING GROUND Repaying debt gradually through payments of principal and interest is called amortization. Today's economic climate has given rise to a reverse process called negative amortization. Negative amortization means that you are losing -- not gaining -- value, or equity. This is because your monthly payments may be too low to cover the interest rate agreed upon in the mortgage contract. Instead of paying the full interest costs now, you'll pay them later -- either in larger payments or in more payments. You will also be paying interest on that interest. In other words, the lender postpones collection of the money you owe by increasing the size of your debt. In extreme cases, you may even lose the equity you purchased with your down payment, leaving you in worse financial shape a few years after you purchase your home than when you bought it. Suppose you signed an adjustable rate mortgage for $50,000 in 1978. The index established your initial rate at 9.15%. It nearly doubled to 17.39% by 1981. If your monthly payments had kept pace with the index, they would have risen from $408 to $722. But because of a payment cap (see .page 6), they stayed at $408. By 1981 your mortgage had swelled from $50,000 to $58,350, even though you had dutifully paid $408 every month for 48 months. In other words, you paid out $20,000 but you were $8,000 more in debt than you were three years earlier. During the next few years, despite the fact that the index fell gradually, you were still paying off the increases made to your principal from earlier years. Certain loans, such as graduated payment mortgages, are structured so that you regain the lost ground with payments that eventually rise high enough to fully pay off your debt. And you may also be able to pay off the extra costs if your home is gaining rapidly in value or if your income is rising fast enough to meet the increased obligation. But if it isn't, you may realize a loss if, for example, you sign a below-market adjustable rate mortgage in January and try to sell the home in August when interest rates are higher. You could end up owing more than you'd make on the sale. © Copyright Federal Trade Commission 6th & Pennsylvania Avenue, N.W. Washington, DC 20580 (202) 326-2222 <-- PREVIOUS PAGE | NEXT PAGE -->