Will home buyers in high cost markets find it more difficult next year to sign up for mortgages that allow them to make low monthly payments through "negative amortization?"

The answer could well be yes -- especially if federal financial regulators force banks and their mortgage subsidiaries to sharply restrict their marketing and origination of negative amortization loans in the coming weeks.

Comments by a top Treasury official last week offered strong hints that new restrictions are likely to be imposed, probably before the end of this month. Comptroller of the Currency John C. Dugan singled out negative amortization loans as a major concern of the Treasury Dept. and other financial regulators. Negative amortization refers to the build-up of principal debt, rather than reduction, that is permitted under various "affordability" loan products used in high-cost areas of the West and East coasts.

Payment-option loans, for example, carry low monthly payments for up to five years because of deferral of principal and interest. Under such plans, a home buyer might start out with a $450,000 initial principal balance on the mortgage, but through payment deferrals have a balance of $475,000 or even $500,000 five years later.

Dugan said regulators are especially concerned about negative amortization loans in real estate markets entering down cycles: "If real estate prices decline -- and there already is evidence of softening in some markets -- these borrowers could face the bleak prospect of loan balances that exceed the value of the underlying properties."

To illustrate the problem, say you buy a $500,000 house with a $450,000 mortgage that you can only afford because of artificially-low monthly payments and negative amortization. Say you purchased the property with the expectation that double-digit housing appreciation would increase the home's market value impressively during the coming several years -- far more than enough to allow you to refinance before the loan's payment-adjustment deadline at year five.

But what if you guessed wrong about appreciation? What if your market goes flat and then trends negative as buyers and investors evaporate? Now you might find yourself "upside down." Your house might only be worth $450,000, but negative amortization might have pushed the debt you owe to the lender to $500,000 or more.

Dugan and other regulators are also worried that many home purchasers using negative amortization plans may not fully comprehend the impending "payment shocks" that will confront them if they can't refinance and have to stick with their "affordability" mortgages.

For example, according to Dugan, a $360,000 payment-option loan with an underlying rate of 6 percent and a five-year payment adjustment deadline would abruptly increase a borrower's monthly payments by 50 percent at the start of year six -- even if market rates remained flat. If rates rose by just 2 percentage points, "the payment increase when amortization (principal reduction) begins would be nearly double."

"Is this an appropriate product to mass market to customers who may be looking at the less than fully amortizing minimum payment as the only way to afford a large mortgage?" asked Dugan rhetorically.

There was little doubt about the implicit answer to Dugan's own question: Negative amortization loans need to be meticulously underwritten and limited solely to borrowers with superior credit backgrounds, solid incomes and big downpayments. They should also be carefully explained even to sophisticated borrowers to make certain that they understand the potential risks of negative amortization.

Dugan's comments carry significant weight. Not only does his unit within the Treasury Dept. oversee all national banks and their mortgage company subsidiaries, but his office also has the lead role in drafting forthcoming new guidance to banks on mortgage standards. He said that the new guidance could be issued by the end of this month.

Bottom line: If you or real estate clients need a negative amortization loan to afford a house, you might want to consider applying sooner rather than later. There is no guarantee such financing will be as widely available in 2006 and it was in 2005.