Posted on 07/25/2005 10:43:25 AM PDT by hripka
I have tried to devise the absolute worst mortgage loan that I can imagine. Fortunately, this loan is nothing more than a figment of my imagination -- at least, as far as I know. But take a cynical guy like me with a looming deadline and this is what you get.
This fictional loan would contain many of the elements that appeal to borrowers hemmed in by affordability. Like today's option, adjustable-rate mortgages, borrowers would be able to choose an interest-only payment or even a minimum-payment option. While the borrower is lured by the minimum payment, what results is a loan balance that grows through the initial years of the loan. This is known as negative amortization.
What is worse than making a payment so low that it doesn't cover the interest? Not making a payment at all. The option to skip a payment or two each year makes the eyes of prospective borrowers light up.
There is a trade-off many borrowers are unaware of: The lower the initial rate, the quicker the rate begins to adjust upward. How many people are in this boat? According to the Mortgage Bankers Association, more than half of ARMs originated in the second half of 2004 face the first rate adjustment within three years. So accordingly, the rate on this mythical loan would adjust monthly and would be pegged to an index such as the three-month LIBOR, so that rising interest rates impact the borrower immediately.
The day of reckoning does ultimately arrive as repayment of the loan balance must begin, at least in some modest measure. To limit the payment shock on this loan, the loan balance will be amortized over 40 years, 10 years longer than the old standard. While the future payment shock is reduced, so is the accumulation of equity.
OK, so I have devised a way to shield the prospective borrower as much as possible from the burden of mortgage payments, at least for the first few years. But how should I address the lack of available funds for a down payment and be marketable to borrowers that don't have a steady paycheck or have launched their own businesses? These contingencies are covered through the no-down-payment, no-documentation feature. By making 100 percent financing available on this product, no down payment is necessary. Neither is the need to prove your income. We'll take your word for it.
This loan would also have two features that are profitable to lenders -- a prepayment penalty and balloon payment. According to a survey by the University of North Carolina, the presence of a prepayment penalty increases the risk of foreclosure by 20 percent, and the presence of a balloon payment increases the foreclosure risk by 46 percent.
The presence of both on the same loan would indeed be rare, but we're talking worst-case scenario, so why not? The borrower would have limited flexibility if either provision were present and would be effectively handcuffed in the case of both. A balloon payment mandates a future refinancing on the lender's timetable and a prepayment penalty limits the ability to refinance on something less than the lender's timetable.
As I noted previously, such a loan doesn't actually exist. Or does it? Each of the components that make it so dreadful exists on other loans currently being offered. The continual evolution of mortgage products is justified with the lip service of "appealing to borrowers with unique cash needs." But the frothier the housing market gets, the riskier new mortgage products become. And unfortunately, borrowers are lapping these up as quickly as the products come to market.
With a loan like this, a borrower with unverifiable income, poor credit, no savings and a tight budget could buy a ridiculously expensive home and be perfectly positioned for the rocket ship of future home price appreciation that will surely continue forever. After all, this is the American dream, right?
On second thought, the idealistic scenario could give way to the reality of a budget-busting financial commitment that leads the borrower into a downward financial spiral. Instead of counting on the best-case scenario of low rates, rock-bottom payments, sizzling home price appreciation and maximum household earnings, it does pay to consider a less favorable, and perhaps inevitable, scenario. Household emergencies do arise and income can drop due to a variety of reasons from illness to job loss or reduction of overtime. That home-based business may not get off the ground as originally envisioned.
Rising interest rates spell higher payments in the future and continued price appreciation is hardly assured. Mix together one too many of these conditions with a loan designed to address affordability only on closing day, and the safe haven of the home could be something far different to household finances.
Naaah. The housing bubble will never pop...
People make negative amoritization payments for two years (give or take a few months) and then due to re-location, job-loss, transfer, divorce, etc. are forced to sell their home when they have no equity.
Then what?
It should pop for someone who chooses an interest only-adjustable-balloon payment loan. Foolish money practices.
"California real housing prices have increased 80% since 1997, which is a greater gap than anywhere but Washington, D.C. According to Christopher Thornberg, senior economist and speaker at the 54th UCLA Anderson Forecast held June 21 in Westwood, Californians are “spending like it’s a full recovery.” And it is not.
A housing cooldown with a soft landing, as well as an economy that will grow only incrementally, is what is in store, according to Thornberg. “The housing market has to start cooling, and when it does, it’s going to have an influence on people’s spending behaviors and that’s going to be a big drag on the state’s economy.” A recession may be in the works, though probably not until 2007. However, for those living for home appreciation, here is his prediction: “In 2011, your house will likely be worth what it is today.”
Thornberg says California is overpriced, particularly for a growing group of residents. “A lot of the population growth in California is low-skilled immigrants who are not making a lot of money and can’t even afford a normal apartment. What we have a shortage of here in California is low-income apartments and we’re not building those now and we’re not going to build them when this thing cools down.”
He asks, “Should you buy a house right now? As long as you’re comfortable with the fact that it’s a low-return investment, then by all means, feel free.”
I bought a car on a variable rate loan in the 1980's and got bitten by that. My 9% loan? Hah, it's 14% after 3 months. I looked at the papers and checked the WSJ for the index they based it on and it would have been 14% from the beginning except they had a cheap rate until the first rate adjustment date. 17 years later and I'm still bitter about it.
One of the new trends in the EU are ZERO percent interest loans. They are done with an eye towards forclosing on the land rather than just making money from loans.
If you throw in the reapair costs up front
( like the old 203b loans...house is worth 100k but 200k if fixed up...FHA/HUD used to finance the 200k from the get go, plus roll all closing costs into the loan)
then I'll take it ! :)
They're already here. Quicken Financial is offering such a program (I think they call it "Smart Choice"). It may actually be a fine program for a speculator, but for someone who plans on staying in their home it's anything but "smart."
Nobody in California thinks that equity is accumulated by making payments. Payments are just the nuisance fee (to be kept as low as possible) you pay to own something that always goes up 30% a year, with no exceptions. ;)
"What we have a shortage of here in California is low-income apartments and we’re not building those now and we’re not going to build them when this thing cools down.”
Low-skilled immigrants are very good at creating their own low-income apartments - all they have to do is choose a moderate-income complex, and move in in large numbers.
Been there. OOPS! .... AM there!
Interest ony loans in Maryland have been running about 25% of all new loans issued.
I figure I will be in a position to buy my first home in about 4 years. Hopefully the real estate bubble will have popped hard and I can snatch up properties for a song.
/Evil Laugh and rubbing hands together
I am thoroughly convinced that 95 plus % of the American people have no more financial knowledge than they did when they were children. What is amazing is that a good many of them run their own businesses or help manage corporations. If they are getting suckered in their private lives, than what about their own business decisions. It's not like mortgages and compound interest are rocket science - these are the basics! Scary man - so many people don't even have the basics. Maybe I'll get into the foreclosure recovery business now, and be situated for all the business that is one the way in that field!
Since MOST people do not stay in their homes longer than 3 years, it actually does not make financial sense to get a fixed rate loan.
That said, most of the McMansions here run $800,000 and up and the majority are interest only loans. As you drive by you look in and see most rooms are bare of furniture. That's REALLY living on the edge.
Then what?
They have a lot more money in their pocket because they had a lower rate than they would of had under a fixed rate loan....
It is not foolish if you are not planning on staying in your home more than 5 years. Adjustibles are smart in most cases because most people do not stay in their homes that long. Adjustibles save those people money, lots of money.
well the real estate market in CA (northern CA) is starting to slow down. Too many houses up for sale and not enough buyers for them. Typical supply/demand issue.
Those big profits will start drying up real quick, me thinks.
However, they missed the obvious reason, which is that so many of the people who love the Jersey shore so much that they vacation there every summer have already purchased their own shore house during the low mortgage craze and are now trying to rent their properties. Problem is, so many of the former renters are now owners themselves. I think the Jersey shore bubble is on the verge of bursting.
Throw in no personal liability on the note and I might take one of those.
I agree that an interest only mortgage on a mcmansion is absolutely stupid. However, sometimes not buying furniture is a good sign of the new owner's financial restraint. It's not how I personally would choose to live - I'd rather have a paid for dining room set than a fancy address, but I suppose there are some folks who'd rather have the mcmansion. 'Cuz you know the same fools with an interest only mortgage are in many cases the same fools buying furniture with no interest/no payments until 2007.
Good friends of mine just bought a house for $660K. They don't make more than $130K together, I surmise. The only thing I can think of is that they are going interest-only. Can't imagine.
Property tax will be around $9,000/ year itself.
Maybe in one out of a thousand cases.
I'm just floored at the housing bubble. And how it used to be that you would only get a house valued at 2.5 of your income. Now there isn't a limit.
You're probably right. The whole concept of a fancy address just to have one is so foreign to me I suppose I shouldn't even attempt to guess what those folks are thinking.
My daughter in law is very involved in her kids' school. She tells me the fanicier the house and car of the kids, the more likely the family is to stiff the collection for the teacher at Christmas, etc.
I think a lot of these people must be teetering on the edge.
I've seen two in the last three months.
Ghastly idea.
Perhaps you could also create a mortgage with a "Payday Loan" feature....if you didn't have the money to actually cover your mortgage payment, you send the mortgage company a check which they'll "hold" until your next payday -- for a small fee, of course.
Are you saying that over 50% of America has a real estate turnover of greater than 33% per year???
All bubbles start with bad underwriting practices.
You are absolutely correct. However, there is a solution: Dave Ramsey's Financial Peace University. It changed my life.
That's actually what I'm doing. Pulled some money out of the market... paid off the house... and am making what would be my normal house payment to my own taxable account.... and investing in large cap paying dividends type companies.
The only thing that makes your deal worse is if you take out this type of loan as a home equity loan :) And then buy a Hummer with the money.
Pay off a house?! Are you kidding? That takes, like, a long time!
Ding, ding, ding!! Smartest comment of the day.
Maybe you're the person to ask this question....my neighbors(scumbags) do not make loan payments all year..every June there is an article in the paper that the Sheriff's office is auctioning off their house and lot, but somehow they manage to come up with the money...well, this June was no different, same article and auction date with the amount of $20,000 owed....I assumed that as always they came up with the money at the last moment...but in Sundays paper they list real estate transactions...and for this property it said...$50,500, sheriff ---County to ----Point Bank, trustee......does that mean another bank bought this property?......PLEASE tell me my neighbors are about to be evicted......
The article makes assumptions and presuppositions that are not based on fact but merely appeals to prejudicial attitudes of the uninformed.
I'll posit a few facts that one might consider before making an uninformed knee-jerk reaction to the idea of an interest-only or neg-am loan:
Albert Einstein stated that the greatest invention of mankind is compound interest.
Leveraging the greatest value of an ever increasing asset (a house) is intelligence.
The value of an house is not affected by the size or type of lien (mortgage).
Losing the leverage (e.g increasing equity, paying off a mortgage) of an ever increasing asset is stupidity.
Every dime of equity a person has in their home is a free gift to the bank and yeilds no benefit to a homeowner. None. It is worse than stuffing your mattress with cash or burying your talent in the ground because you have to sell the house to realize any value. Every dime of equity decreases the leveraging power of the home including the tax advantage.
Maximizing present cash flow, always trumps future savings. Always.
Maximizing cash flow, maximizing the tax advantage, and increasing your leveraging power is the best stewardship of your finances.
I couldn't disagree more. I've owned my house outright for several years. And let me tell you since I only owe approx 3000 a year in property and school taxes, I can live like a king these days.
I understand what you're saying, and from a completely mathematical standpoint, what you say makes sense. But the average person doesn't live in a theoretical world. We live in real neighborhoods, where we get used to the schools, stores, and church. It's called planting roots.
Owing more money every month than you've got coming in is no way for a family man to live. It's the ant and the grasshopper. The guy paying down his mortgage is looking down the road to a carefree retirement. The guy with the money in the bank, but no equity in his home is looking at an expensive last couple of decades.
actually the housing bubble has popped in Austraila, where the consequences have been relatively benign.
In Australia approximately 95% of the population lives in cities where housing prices rose more than 15% annually since 2001. Also in Australia nearly all home buyers buy with Adjustable rate mortgages.
The USA doesnt face nearly the bubble Australia faced and yet Australians experience thus far with a popping housing bubble has not lead to a recession or panic in the housing industry
Its ok. :-)
I've owned my house outright for several years.
You've stuffed your mattress. You've buried your talent in the ground. Congratulations.
I can live like a king these days.
You could (live like a king) if you weren't affected by the stupid tax. Let's say your house is worth $200k, then you could earn $16-20k (depending on taxability of investment) per year with a modest investment. The loan would cost approximately 12k (even less with neg-am). 4k-8k is your opportunity lost. I call it the stupid tax. And since interest compounds, in 5 years that opportunity lost is about $65,000. In 10 years its almost 160k lost. And since the mortgage payment is taken directly from the investment there is no worry. Aamof, if you set up an automatic payment, the only worry you'd have is deciding where to deposit the 65k.
I understand what you're saying, and from a completely mathematical standpoint, what you say makes sense. But the average person doesn't live in a theoretical world.
It's not mathematical theory to thousands of homeowners nationwide. Its reality.
We live in real neighborhoods, where we get used to the schools, stores, and church. It's called planting roots.
You've lost me here. Leveraging does not jeopardize longevity nor uproot homesteads. On the contrary, it provides resources to reinvest in the community. If you had an extra 65k to pass around the neighborhood.....
Owing more money every month than you've got coming in is no way for a family man to live.
Ah Hah! Thank you for demonstrating the offensiveness of this threads main source. The article implies that interest-only and neg-am loans are unaffordable now and/or in the near future. The article also implies that (nationwide) home values are inflated. Nothing could be further from the truth. Home values are supported by our economy. It would take an economic crash for homes to devalue. And if that happens, home affordability will be the least of our concerns.
It's the ant and the grasshopper. The guy paying down his mortgage is looking down the road to a carefree retirement. The guy with the money in the bank, but no equity in his home is looking at an expensive last couple of decades.
This twisted logic explains Matthew 25:25-30, so I have to disagree with you. The income from a leveraged home can pay its own mortgage off in a little over 10 years. But why even do that (pay it off) when your assets are greater than your mortgage, there is no risk at all. Keep your home leveraged and keep earning the reward.
Blanket statements are a dangerous thing. Why don't you peddle your "strategy" to my neighbor who bought his condo at their initial offering of $140k in the mid 80's and tell him how he has a better deal than those of us who bought at $60k-$80k during the real-estate bust of the early 90's. Real-estate doesn't always "go up"
Also realize that increased home values can't buy you a loaf of bread until you sell (or re-fi w/ cash out) the home.
And I just love my tax break. Uncle Sam lets me pay the bank $1.00, and I get $0.40 back. Spend $1.00 to get $0.40, that's a sure way to make the bank rich and yourself broke.
Bookmarking.
The OC Metro article wasn't entirely forthcoming in that they failed to mention banks (ie. Wells Fargo) putting mobile units on the street to attend matricular consular fiestas.
These folks aren't so much interested in your "reinvestment into the community," equity, or any other thing, as getting their foot in the US door.
They can't, as OC Metro so ambiguously states, afford a marginal apartment. Four or five levels of financing is what's called for in many cases along with "suggestions" of co-ownership, renting of rooms, etc. I won't go on ... it's gruesome
I can't believe it's reached this state of affairs in Indiana ... and you appear to be in the "biz." When 10 cars are commonly parked around one home and "homeowners" put pylons on the curb (though all have driveways) to protect "their spots." What can I say? Watch out!
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