Here is an explanation I sent to a short sale guy. Long and boring if you are not really interested in the mortgage thing.
Repeat: Long and boring if you are not really interested in the mortgage thing.
Negative amortization loan
This will not explain, nor will it theorize the blame, philosophy, or legislation pertaining to the loans. This is just a theoretical example of the way it is. (or was)
Example home: Florida, 2005, typical loan. (could be almost any state)
Value: 250K Appraisal: 300K (This is an illustration. Of course high appraisals didn’t really happen) Loan: 80% LTV 240K (for now, make believe there was no 2nd for 30K)
Interest rate: 7.5 Insurance and taxes 8K a yr. (remember, this is Florida, where insurance on the coast is extreme) Principal and Interest on a 30yr loan @ 7.5%=1678.11 Interest only pmt= 1500.00 Total PITI pmt= 2344.11
Now the good part. Wamu, Countrywide, IndyMac, World Savings, etc (all gone, btw) would allow you to pay back at a 1.5% rate for 5yrs or until you got to 125% of the original loan. Then the loan would “re-cast”. Then you would have to pay principal and interest to pay back the balance in 25 yrs, not 30. Here is how it worked.
The interest only payment on the original loan would have been 1500. At 1.5% payment rate, not loan rate, you are only paying 828.29. That is 671.71 less than the interest only payment, so you are adding that amount (671.71) to the back of the loan every month. In effect, you are borrowing every month, so at the end of 5 yrs, you have added 40302.60 to the loan. Now you will be at 125% of the first loan, and the loan will get recast.
In this example, here is a picture of the new loan. (if this sounds too crazy, ask a Florida Real Estate Broker or a recovering mortgage broker)
2010 Value: 150K Appraisal: 140K 80% LTV loan= 120K
You now owe 300K at 7.5% on a 150K property. You have 25 yrs to pay it off. The 25yr loan of 300K at 7.5% brings a new payment of 2216.97, plus the escrow, for a new total of 2882.97. An increase in your payment of 1388.68.
You owe 300K on a 150K home, and you are shopping around to see if you can qualify for a refi. Did I mention in 2005, you got a stated income, no or low doc loan? Now you will have to verify the income you lied about. And your credit score hopefully is still very high. (of course, with the value being what it is, it may be a moot point.)
This is why the mortgage crisis may not be as close to being over as many think. The heyday of the neg am loan was 2005, 2006, into 2007. The 5 yr clock from those loans is ticking, and many savvy people may just decide it is not worth an increased payment of that much to save a home that has decreased in value rather than increased as expected when the loan was originated. Of course, it is also possible many of the well intentioned homeowners won’t have a choice, as they can’t pay even if they want to.
Remember back in the beginning about the 2nd loan? Many equity loans were interest only for a given amount of time. Even if the homeowner can get a 5.25% new loan, the equity loan has to be paid off. With the new loan, plus the equity loan, you are looking at 330K. At 5.25, the loan payment is 1822.27, plus escrow, which is still higher, but palatable, but nearly impossible to get with the new LTV, and documented income.
Who changed the borrower requirements, and why, is a whole different thing. And why an individual would want a negative amortization loan is also a far more complex thing to get into. Hopefully this example will help you understand some of the dynamics to the neg am loan.
Thanks, I know how that all works. I was just pointing out that people didn't think property values would fall in any meaningful amount.