Mortgage Madness – Homebuyers Beware

Posted on May 19, 2007
Filed Under Mortgage Smarts, Personal Finances | Leave a Comment

The headline below is from a popular website that is a perfect example of how some players in the mortgage industry have lost all perspective, left the real world of sound business, and moved on to “fantasyland”.

Along the way they’re leaving a trail of folks forced into foreclosure, and/or bankruptcy, not to mention trashed credit. The problem has already become large enough that the feds are talking bailout.

Unfortunately, it continues to draw people in unaware, even though the pitch screams out “BAD IDEA” on so many levels it’s hard to pick a place to start describing the pitfalls.

$580,000 Mortgage for Under
$1698/Month!*
Mortgage Rates Near 39 Year Lows!

It plays on the old tried and true ploy of enticing folks to forget that “there’s no such thing as a free lunch”, and it’s amazingly successful. Why? Because people want the free lunch so bad, they start believing the rules of the game don’t apply to them….

Ignorance is no excuse either. And by the way, being ignorant about something is not a bad thing, it simply means one doesn’t know or understand aspects of that thing. All ignorance is curable by the acquiring of information and some studying of that data.

In this case being ignorant of the facts should be setting off all sorts of alarms. Any response short of an “about face”, should be to find out what’s the catch.

The catch is that even if you make the stated payment every month, the loan will never be paid off. Furthermore, for every month the payment is made, you will owe approximately $1400 more which will be added to the loan balance.

This means the payments never stop, and the debt increases substantially each month.

So why would anyone want to do such a thing? Good question. Answer is, they shouldn’t, but folks get drawn in by the come-on of the absurdly low payment for an expensive house. Problem is, it won’t last.

In fact the lender knows this and will only let it go on for a certain period. But long enough for you to owe them 1000’s of dollars more on a property now worth far less than what you owe. That means even if you were to sell it, you wouldn’t get enough to pay off your mortgage obligation.

This by the way is in the fine print at the bottom of the advertisement. Truth-In-Lending Laws require certain disclosures which are shown in this fine print. Here you will also find a realistic payment amount. In this case, $3665.99, which will actually pay off the mortgage in 30 years.

*The $1692.00 payment is based on the borrower selecting the minimum monthly payment option on a $580,000 adjustable first mortgage loan using a minimum payment interest of 3.500% (which is calculated by taking the actual interest rate minus 3.00%). The actual interest rate is 6.500% with a 7.395% APR.

By selecting this option, the loan has the potential for negative amortization. The minimum payment does not cover all of the interest that is owed for the month and, therefore, you will incur deferred interest that is added on to the balance of the mortgage. You may make the minimum monthly payment for up to 5 years or until your new mortgage balance is 115% of the original mortgage amount. The borrower also has the option of making an interest-only payment or making principal and interest payments amortized over 30 years. For example, if the borrower selects to make principal and interest payments amortized over 30 years, the monthly payment will be $3665.99. These terms are available for first mortgage loans. To qualify for this monthly payment, the property must be owner occupied single family residence and have a loan-to-value ratio of 80%. Credit restrictions may apply. Rate is variable and subject to change daily without notice.

At least this advertiser is following the rules and disclosing. Many don’t. If you ever want to see what a realistic payment should be for a mortgage, or any other loan, just google “financial calculators”. Then pick one of the sites and go plug in the numbers.

Back to the case at hand, despite the fact that details regarding negative amortization, and other risk potential is shown in the fine print, folks will still be drawn in. I mean who cares if the real payment is $3665.99 and I can get it for $1698.00? Why not? For the same reason you don’t touch a hot stove – you’ll get burned.

This type mortgage is designed for a couple very narrow purposes, and only one is even close to being valid – and then only for a pro, because it’s for speculators, not for the average homeowner intending to stay in the house.

It works with property that is rapidly appreciating in value. The idea is to lock in the house at today’s price and sell it in a couple years for a substantial profit. In the meantime, the loan can be serviced at less than half a normal payment by accumulating deferred interest which will be paid off at the time of sale, still leaving a hefty profit.

The downside, is what happens when the property doesn’t appreciate as predicted. Losses can be sizeable – that’s why it’s for people with the means to undertake the risk. Remember the old saying “if you can’t afford to lose, then you can’t afford to win”.

The other use is for folks expecting a windfall, or some sizeable increase in their income which would allow them to get in the house, then step up to the real payment after a short while.

For the most part, people doing this are deluding themselves. They believe their income will increase, but have no idea how much it would have to increase for them to actually afford the new payment.

An easy rule of thumb is that your income would have to more than double for this to work. Because this just isn’t going to happen for most people, this type mortgage shouldn’t even be considered.

The bottom line is that this site is simply attempting to exploit consumers. That much is obvious from the bold headline that clearly targets the average Joe or Jane homebuyer, who as we’ve already seen, would not be well-served by this type product.

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