DEAR BOB: I am a new real estate sales agent. As mortgage interest rates slowly rise, I’ve seen mortgage lender ads that say, “No negative am.” What does that mean? – Cheryl R.
DEAR CHERYL: “Negative amortization,” also known as “negative am,” is a very important mortgage term every home buyer, real estate agent, and refinancing home owner must understand.
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Mortgage negative amortization can only occur with an adjustable-rate mortgage (ARM) when the interest rate adjusts more frequently than the borrower’s payment adjusts, or the indexed interest rate rises faster than the borrower’s monthly payment increases.
For example, most ARMs have monthly payments that are “locked” for one to 10 years. Many have fixed monthly payments for the first three to five years.
However, if the ARM interest rate adjusts monthly, semi-annually, or annually–although the borrower’s monthly payment remains constant–if the interest rate rises, the unpaid interest is added to the mortgage balance.
The result is “negative am,” meaning the borrower might owe more than was originally borrowed.
To illustrate, suppose the starting ARM interest rate is 5.5 percent and that ARM interest rate is based on an index rate, such as the Cost of Funds index, plus a “margin.” Let’s say the starting index rate is 3.5 percent and the margin is 2 percent, resulting in the 5.5 percent interest rate that could be locked for several years. If the index rises to 4.5 percent, but the borrower’s payment remains fixed, the unpaid 1 percent interest amount is then added to the mortgage balance.
To summarize, try to avoid an ARM with negative amortization. The problem is many ARM lenders don’t offer ARMs with locked payments for more than a year or two without negative amortization.
LOSS ON INHERITED PROPERTY USUALLY NOT TAX DEDUCTIBLE
DEAR BOB: My mom died in February 2003 in Austin, Texas. She owned her home and left it in a life estate to my niece. In April 2005, my niece decided she didn’t want to live in the house any more and tried to sell it. But she couldn’t sell her life estate. So she deeded the house to my brother and me. We do not live in Texas. When mom died, the house was valued in her estate at $182,000. It was sold for $150,000. My brother and I each received $49,000, after paying expenses and the mortgage. Do we owe any capital gains tax? – Reva J.
DEAR REVA: From your description, it appears mom’s will left the house to you and your brother, subject to the niece’s life estate. You and your brother are called “remaindermen” because you control the house after your life tenant dies or renounces her life estate, as she apparently did.
If the house was worth $182,000 on the day your mother died, that is the “stepped-up basis” for you and your brother. Apparently, the house declined in market value to $150,000 at the time it was sold. Therefore, you and your brother have a capital loss.
Your share of the capital loss can offset any capital gains you have on other assets you sold in the same year as the home sale. If you can’t use your entire capital loss share, you can deduct your share at the rate of only $3,000 per year against ordinary income in future tax years. For details, please consult your tax adviser.
DEEDING PROPERTY TO MORTGAGE LENDER MIGHT BE TAXABLE
DEAR BOB: Eight years ago I bought a house and lived in it for five years. I moved out but continued making mortgage payments thinking I would be able to sell it. Due to a notoriously bad water problem in the area, houses were not selling. I just recently deeded the house to the mortgage lender after having made mortgage payments during the three years the house was empty. Do I have a long-term capital loss? – Kenneth J.
DEAR KENNETH: Worse than a capital loss, you might have a taxable “debt relief” situation because you were relieved by the lender of your mortgage obligation. Debt relief is often taxable. Please consult your personal tax adviser for exact details.
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