The Negative Amortization Home Loan is the Mortgage industry’s dirty little secret.
A “Pick a pay” or “Negative Amortization” mortgage may sound like a cheap way to get into your dream home, but they will actually end up costing you your equity—and that is the good news! These loans not only keep you from building equity in your home, but they may end up putting you in a position where you owe more than your home is worth. If no equity or negative equity doesn’t bother you, it should. If you lose your job, or are transferred and have to sell, you will be paying money out at the closing table just to get out from under the mortgage.
Adjustable rate mortgages are just as dangerous and negative amortization home loans.
They start out at a low rate and ply you with sales talk about the payment increases being no big deal because you can expect your income to rise as you climb the ladder of success in your job. I don’t know about you, but my household is making about 15% LESS than we were 5 years ago.
No one can predict the future and tell you that you will be making more money in 5 years than you are now. If it happens, that’s great, but there are no guarantees. Lenders will also tell you that you will be able to sell your house or re-finance if the interest rate adjusts too high. When I was in real estate, I saw many folks who needed desperately to sell and ended up losing their homes to foreclosure while the house sat on the market. And as far as re-financing, if you cannot qualify for loan with a lower rate, you are stuck with struggling to pay the ever rising payment.
Beware of phrases like “low payment rate”. This phrase sounds like “low interest rate” and it even has a percentage quoted that sounds like an interest rate. The low payments are not permanent. They stop after five years, then you must pay the full payment.
You may think that you can just sell your house in five years and move on, but if your property value has not risen considerably, you will not be able to sell for a price that will cover your new inflated loan amount.
All the payments you make during the first five years are actually partial payments. The part that you do not pay is added onto the balance of your mortgage. So you may have borrowed $200,000 to purchase the home at a low payment of $700 a month. After five years of making partial payments, you must start making full payments of $1500 a month and your loan amount has risen to as high as $250,000! If you can’t afford the new payment and try to sell, you will probably not be able to sell your house for $250,000.
With the trends of the past few years, you may not even be able to sell it for the price you originally paid.
Misleading terms will make you think that you are getting a great, low rate—like 2.9%. But the 2.9% is actually a margin—or the amount above the index (usually prime rate). So if you have a margin of 2.9% and the index is prime rate (say, 5.5%), then your actual interest rate is 8.4%–not such a great rate.
Always ask if there is a pre-payment penalty. Pre-payment penalties are fees that your lender will charge you if you pay your mortgage off early (in the case of re-financing or selling your home). Most people will want to refinance or will sell the house long before they pay off the mortgage. It is not hard to find good loan programs that have no pre-payment penalties at all.
You may be wondering which loan program is the best. The thirty year fixed rate mortgage is the best option for homebuyers. At the writing of this article, the commonly advertised rate on a fixed rate thirty year mortgage is 5.25%—outstanding.