with an interest only loan
Interest-only is a loan for suckers! Behold! I give you the
Option ARM! Imagine a loan in which you could actually pay
less than interest, and continually accrue a negative amortization until you hit, say, 110%, 115%, or 125% of principal (or five years, or whatever the contract specifies as the breaking point), at which point the loan recasts for the new principal at market rate. It's like paying rent on a house that you already have a mortgage on. Quite a deal, really.
No, I'm totally not making this up. It exists. $1500/mo for a $400k house might be a *bit* of a stretch, but not much. Not much at all. So you can end up, after making your option payments on time every month, owing $500k on a $400k house that you've been paying on for years.
No, not much of a stretch at all. For the last four years Ive been scratching out a living as a notary signing agent. The hoyty-toyty title is loan signing specialist but its really just a notary trained to present and explain the basic documents in a loan package.
Interest only is not just for suckers. Have a look at the amortization schedule on your first mortgage; in a thirty year fixed loan the amount of principle included in the payment for the first few years is almost negligible. An Interest only loan is really just a marketing gimmick to make the slower members of the herd think theyre getting something they are not. Ive not heard the term Option ARM before but this could be a nebulas term to further disguise an interest only. Qxxxxxx Loans comes to mind; they have a plan that lets the borrower pick their payment . One can make a conventional payment, interest only, half interest only, interest plus extra principal, or even skip a payment entirely; all on the whim of the borrower. Do keep in mind the pay-off date; skipped payments will show up as a balloon payment at the end of the loan plus any interest skipped will be taken off the next few principle payments. I have presided over more than a few of these.
Whats causing all the trouble in the present market is the Adjustable Loan with adjustable interest , something the good folks over at Q are very good at marketing; on the other hand several major lenders have been in the news for the same practice, CW comes to mind. Here is how it works, mind you Im working on memory from a loan I signed a year ago and have no copies of documents to refer to. The borrower re-fid his premium from an existing 30yr fixed, call it 300K. He bought the 5/ 25 plan which means he had five years of half interest payments of about $500, the going rate for his loan was 8% so the payment represented a 4% increase, of the interest amount, in the principal amount of the loan every month. At his 61st payment the loan will adjust; to whatever the current interest rate of the day is and became a free floating adjustable and his payment jumps to $1200. There is an additional adjustment on the due date of the 85th payment, $1500 for the balance of the loan with a pre-stated possibility of a balloon payment for any unpaid principal on the maturity date. BTW, total payments dont include taxes, PMI, or possible HOA fees.
Those of you feverishly scratching on paper with the stub of a pencil have already figured out that the principal of the loan increased by 30K at the end of the five year period. The payment of $1200 is probably a close estimate of what he should have been paying from the get-go and the $1500 payment representes the dollar amount needed to maintain the original 8% amortization schedule for the remaining life of the loan. Dont forget the loan will be free floating from month to month at this point or that the principal would have been negligible for the first five years anyway. Did he make a mistake?
Only time will tell that tale. He might bank the savings for a future re-fi but given his age, profession, and the presence of a slinky blonde girlfriend I dont think that will happen. He might marry the woman and sell one or both homes to consolidate both their debts; they both own a condo in an up-scale area. As long as he intelligently re-fis in less than five years, he will be ahead of the game. I dont think intelligence is his strong suit; he and GF downed a bottle of wine in the hour it took to get through the documents.
Azraels got a good grasp on the nubbin of the problem. A lot of people have bought into this kind of loan and this is the reason the mortgage market is in a crises. A lot of bad decisions are being made and just walk away is one of them, it could be considered economic suicide. There is also a snowball effect, every loan that defaults wills increase the interest rate for the rest of the pool of people paying a mortgage. Lenders will have no choice but to edge up a quarter point or more to re-coup loses, just like insurance companies up rates to cover the loss from un-insured drivers.
Da Bianhua
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