How Can I get The Best Deal On A Home? Where Do I Start? Part IV

How can I get the best deal on a home? Where do I start? Part IV

It is essential that you understand some of the pitfalls of mortgage loans when making

the determination as to which is the best loan for you. You should be very familiar with

each loan program you are considering.

In the rather lengthy Part 3 we discussed several loans, how they work and some

of the pitfalls related to each. Naturally, you should discuss these loans with your loan

consultant in detail. Make sure you are completely comfortable before making the decision.

The last loan that will be discussed is the "Pick-A-Pay" or the "Pay-Option-Arm." This

type of loan offers the greatest number of options for the borrower. Each month they

can decide to:

1) Pay the fully amortized (paying principal and interest) payment

for a 15 year payment period. (The highest dollar payment.)

2) Pay the fully amortized (paying principal and interest) payment

for a 30 year payment period. (The Gold Standard for loans.)

3) Pay the interest only (the original principal remains the same)

payment. (A lower monthly payment.)

4) Pay a "teaser" interest payment, far below the market interest

rate which will not even cover the monthly interest for the loan

principal. With this option, the difference between this "teaser"

payment and what you actually owe is added to the outstanding

loan balance EACH MONTH. This phenomenon is known as

negative amortization.

Depending on the lender, once the principal balance reaches 110% to 125% of the

original loan balance, the loan recasts. That means that all the rules change and

your payment takes a giant leap upward.

Another issue is that the interest rates are adjustable and tied to a financial index.

The borrower has no idea what is going to happen to their interest rate. There are

caps involved but the caps allow interest rates that result in frighteningly high

payments.

If we go back to our $ 250,000 loan amount used in Part 3 and maintain the 6%

interest rate, the four payments would look like this:

1) 15 year fully amortized payment........$ 2109.64

2) 30 year fully amortized payment.........$ 1498.99

3) 30 year Interest only payment.............$ 1250.00

(remember with this one you are NOT paying down the principal!)

4) 2% Teaser Rate payment......................$ 416.67

(The difference between this payment and the $ 1498.99 above is

added to your loan total EACH MONTH.)

After two years of this payment history your principal would be

$ 275,975.68, over 110% of the original loan! When the loan recasts

an interest rate of 11% is not unlikely. At that rate your new payment

would be $ 2628.18! That is 175% of the original 30 year fully amortized

loan payment.

We are sure that many people in 2004 - 2006 committed to this kind of a loan package

knowing that their home value was increasing at astronomical rates and certain that they

could always sell and get out from under that loan obligation if necessary. Unfortunately,

for far too many in this position, property values dropped. Thus the foreclosure boom.

Experience teaches us that risky loans can produce disastrous results. Negative amortization

was attractive bait created by investors to increase their yield. However, it backfired

on both those who committed to those kinds of loans and well as the investors who were trying

to take advantage of the market.

Caveat Emptor (let the buyer beware) really applies to this category of loan!

Stay tuned for the next Blog in this series.