I want to follow up on my last column about flexible payment mortgage plans, which allow the borrower to choose from four different payment options in any given month. To recap, here are the payment options typically offered:

• The Minimum Payment - The lowest payment option is usually less than the interest charged, resulting in negative amortization, or "deferred interest."

• Interest Only - This payment covers the interest charged during the month but excludes any principal curtailment. The principal balance does not change.

• 30 Year Amortization - A payment based upon a 30 year payoff period.

• 15 Year Amortization - A payment based upon a 15 year payoff.

Each payment plan has its advantages and disadvantages. Paying a loan off in 15 years requires a hefty payment which may be difficult to afford. On the other hand, an accelerated payment plan will save you thousands of dollars in interest over the life of the loan.

By contrast, a loan payment that results in negative amortization means that the payment doesn't cover the interest charged for the month, so the difference is added to the loan balance. This means the balance will increase every month but the monthly payment is very low, giving the borrower more flexibility with their money.

The appetite for low payment mortgages has increased in response to rising home prices. Lenders have responded by adding more "flex-pay" programs to the mortgage menu. Today I want to talk about loans that allow negative amortization. There's a lot of misleading information out there and I want to set the record straight.

The minimum payment on these "flex-pay" mortgages is based upon some predetermined calculation. Here's an example:

The payment might be based upon a 30 year amortization with an interest rate of one percent. With a $300,000 loan, my calculator tells me that the minimum payment would be $965 per month. The "one percent" should be referred to as the "payment rate" because you can bet your bottom dollar that it's not the true interest rate of the loan. Let's take it a step further.

This loan carries an adjustable rate tied to a popular index, the Monthly Treasury Average, which is currently yielding about two percent. The loan carries a "margin" of 2.50 percent over the index, creating a "fully indexed" rate of 4.50 percent. This is the actual interest rate on the loan.

In order to avoid negative amortization, the borrower would have to make a payment large enough to cover the interest charged at 4.50 percent. Multiply $300,000 by 4.50 percent and divide by 12 months, the monthly interest charged is $1,125.

But the minimum payment is only $965. If the borrower makes the minimum payment, the difference would be added to the mortgage balance, increasing it to $300,160.

As I said, this is fine as long as the borrower is aware of what's going on. The problem is that many borrowers mistake the "payment rate" with the actual interest rate and this, does not surprise me. Radio and newspaper ads are filled with statements such as "Rates as low as one percent! Call us today!" And these ads don't just come from the oft maligned small mortgage broker -- many large national banks carry on with the same practice.

The unsuspecting consumer sees the ad and thinks he can get a mortgage loan with an interest rate of one percent. It's misleading -- plain and simple. The bottom line -- if something looks or sounds too good to be true, it very well might be. Caveat Emptor.

Published: February 17, 2005

Use of this article without permission is a violation of federal copyright laws.

, the president of PMC Mortgage Corporation in Alexandria, VA, is a mortgage columnist whose work has appeared in numerous consumer, real estate, and mortgage publications. Mr. Savage welcomes your questions for possible use in this column, however because of the volume of mail received, Mr. Savage cannot answer questions individually.