Non-fully amortized mortgages — watch out!
June 9th, 2007 at 9:29 am (Finances, Society)
Like homeowners everywhere, I am regularly inundated with mail offers to refinance my mortgage. I have no desire to refinance the quite attractive interest rate I got when I bought my home, so most of these go straight to the shredder. But sometimes the mortgage companies disguise their offers in blank envelopes, so I open them before realizing what they are.
Today, I received an offer (from Union Fidelity Mortgage) so egregious that I had to share. Ignoring the complimentary “vacation for two” being offered as a teaser, here is an excerpt from the front page:
Loan Amount New Low Payment** $300,000 $759 $400,000 $1,012 $500,000 $1,265 Examples shown based on APR 7.13%.
** See other side for important information.
Wait a minute… a $300,000 loan at 7.13% for only $759/month? That doesn’t look right. I whip out my calculator (actually, bc -l) and determine that the interest accrued on $300,000 at 7.13% in a single month is $1782. Therefore, after making your payment, you would still accrue $1023 each month… on top of the principal, which you wouldn’t have paid down at all. How can this be?
I turned the page over to read the “important information”, in all of its hideous glory:
Payment shown in the minimum payment for the first year and is available on a non-fully amortized loan of 40 years based on a 1% payment rate. If this payment is made it will result in interest being deferred to the balance of the loan. It is possible at the end of term to still owe principal. If this payment is made no principal is paid down. APR shown is variable rate with an annual cap of 2% and lifetime of 10.9%. Payment can increase by a maximum of 7.5% per year on payment minimizer.
I have bolded all of the gotchas. I’m actually not sure what they mean by a “1% payment rate”. But it’s clear that the low-low payment of $759 is only permitted for the first year. Who knows how high it will go next year? There’s a cap on its increase of 7.5%, but obviously you aren’t doing yourself any favors by keeping that payment low — you’re just accumulating more and more “deferred interest”. At the end of the first year, you will have paid $9108, and you’ll owe $312,276. You’re racking up debt to “Union Fidelity” at a rate of more than $1000/month for the privilege of… what? Living in the moment? Robbing your future self to pay the present? (There may be those who would intentionally choose such a loan, counting on an increase in equity to compensate for the mounting loan balance, but that’s way outside my comfort zone in terms of rational risk.)
And that’s not all. That assumes that the interest rate stays at 7.13%. But according to these terms, not only might the minimum payment go up, the interest rate itself is variable and can go up by 2% each year. Ouch.
But wait, there’s still more! Unlike traditional 30-year loans, or the more cost-effective 15-year loans, this one is a whopping 40-year loan. If fully amortized (that is, you pay interest as it accrues *and* pay down principal on a 40-year schedule, so as to not end up owing anything at the end), the monthly payment should be $1893. Anything less than that just helps you dig yourself a financial hole so deep you may never get out. And if you do make that fully amortized payment, then over the 40 years you will pay… wait for it… a total of $608,490 in interest. *Twice* the amount of your $300,000 principal! (A 30-year loan with the same rate, fully amortized, would have you paying $427,980 in interest.) And the reality, with this loan, would be so much more costly.
This stuff makes me sick to my stomach. In terms of “learning”, this was a yet another one of those sit-up-and-take-notice moments, and a chance to be surprised anew at how manipulative and opportunistic money lenders can be. Before today, I wasn’t even aware that “non-fully amortized” loans existed. Or maybe I’d just turned an instinctive blind eye.
To top it all off, the microprint for the terms concludes with:
This is a great loan for many different circumstances.
Do tell, Union Fidelity Mortgage. Just which circumstances make this a “great loan”?
stough said,
June 9, 2007 at 11:32 am
I learned, like you that this is even more egregious than I thought!
Why this is a “great loan“:
1) It’s a great loan if you’re the lender! You either make a killing on interest, or you get a house that (more than likely) is worth exactly what you loaned or more, and you get the right to foreclose and maybe garnishee the wages of the stupid borrower.
2) This loan is great if you either can see the future or influence the market such that you know that rates will plummet soon or that your house will increase in equity very quickly.
3) This is a great loan to encourage new or recent home buyers to take so that, in a year or two the foreclosure market is even better than it looks to be for people like me who want to get back into the market! This dovetails nicely with reason (1).
4) It is an excellent loan to use if you have a stolen identity and intend to rent the property. You just buy it, rent it, and funnel the profits into an off shore account. When the tenant sues you for neglecting the property even though they’ve been paying their rent on time for 3 years, you’re already relaxing in the Caribbean!
I’m sure that there are more, but it doesn’t look like it’s ever a “great loan” for the home owner.
Cheers,
Tim.
wkiri said,
June 9, 2007 at 12:00 pm
That’s pretty much where I got in terms of my analysis. :) Great loan for the lender, but no one else!
I like the stolen identity scenario. You could certainly rent a $300,000 home (if they still exist around here) for more than $759/month. And with your stolen identity, you could let UFM just foreclose on the house when you’re done and absorb the losses, I guess!
jim said,
June 9, 2007 at 7:21 pm
Wow. This is even more sinister than the Equity Accelerator offered by Washington Mutual to “manage” sending in the equivalent of a thirteenth payment each year. (Its fee structure would be effectively 30% of the interest saved)
Given how the other terms are designed, I’m surprised they cap the interest rate at 10.9%. I would have expected credit card levels. Was “the other side” one point font?
The beauty of Tim’s #1, is the poor schmuck using this loan will also have PMI (private mortgage insurance) to further reduce the lender’s exposure to the 20% magic number.
For #4: think “surprisingly large, nonrefundable damage deposit“
wkiri said,
June 10, 2007 at 6:25 am
Jim: I’m surprised they cap the interest rate at 10.9%
Ah, no, I believe they’re saying that they cap the lifetime *increase* at 10.9%, meaning that the real cap is 18.03%. So, yeah, credit card levels. :)
jim said,
June 13, 2007 at 6:07 am
I use bc all the time for simple stuff, but was unaware there was a newer one with mathlib extensions. Props for the tip!
What I Learned Today » Blog Archive » Reassess This said,
March 25, 2009 at 10:46 pm
[…] a homeowner, I’m used to getting all sorts of shady offers in the mail for new mortgages with astoundingly bad terms. But now that home values are declining, the free market has spawned a new kind of scam, at least […]