• Choose a category
• All
• Classic-Fiction

Option ARMs allow negative amortization, meaning a homeowner’s principal balance—the amount you’d pay if you pay off your loan right away—can potentially rise. Borrowers may have initial payments so low that the payments do not even cover interest costs. Unpaid interest increases the principal amount, the loan balance, resulting in negative amortization. What if you bought a home with no money down (no down payment), and home prices fall? You are in an “upside-down” mortgage. You owe more than the house is worth, and the amount you owe grows bigger every day. As the song goes, you get “another day older and deeper in debt,” and if you sell the house, all you have left is debt. You never bought a home, you simply signed for a loan that you cannot pay off. You are much worse off than you started. These loans are vampire loans because mortgage lenders who keep these loans in their portfolio find that they look better dead than alive. The principal balance increases; the loan value appears higher; but the reality is that the borrower may be about to default on a payment (or may have already defaulted on one or more payments). Sophisticated investment bankers knew this, but they bought these loans from shaky mortgage lenders, packaged them up, and sold them anyway.

As Warren Buffett points out, if you lend money to people who cannot pay you back, it will not end well (and it hasn’t).

Homeowners with equity in their homes are encouraged to refinance with “no-cost” loans. In my opinion, this term should be made illegal. There is no such thing as a no-cost loan, albeit this type of loan may make sense for homeowners planning to move in a year or two. Fees are buried deep in the mortgage documents as a yield spread premium. Usually a borrower pays around 2 percent of the loan amount in closing costs. On a $100,000 loan there are about $2,000 in closing costs. With a no-cost loan, the mortgage lender builds fees into the interest rate, and the borrower pays the fees over time. Since the lender sells the loan to an investment bank, the lender makes money because the loan paying a higher interest rate sells for a higher price, so the lender gets his money right away. Lenders are not required to tell a borrower how much this is worth, and most borrowers—even educated, intelligent, otherwise savvy homeowners—do not know where to find the yield spread premium in their loan documents, which seems like pages of boring jargon, much less calculate what it is worth. Warren counsels that you should not invest in something you do not understand, and that would also apply when taking out a loan to “invest” in a home.

The borrower may be getting a loan with a higher interest rate than he or she could get through another broker or through a traditional bank. Brokers doing this often raise the rate by 0.5 percent over and above the closing costs and what the borrower would otherwise pay elsewhere. For a $100,000 30-year fixed-rate loan, the extra charges mean additional interest payments of $11,500 above the closing costs already built into the interest rates. Honest brokers will run the math for a homeowner, show the borrower all of the fees, and calculate the breakeven ownership time period where the borrower will be indifferent between paying the closing costs upfront or paying the closing costs over time embedded in the monthly payments. Honest brokers will not fee slam by stuffing an extra 0.5 percent into the yield spread premium above and beyond the closing costs. There is no such thing as a no-cost loan.

Some brokers of no-cost mortgages will only pay appraisers at closing (when borrowers sign documents to buy the home).They claim the appraiser will otherwise not work as hard to fairly value the property, but the opposite is more likely. A higher appraisal makes it more likely the deal will close, and the appraiser only gets paid at closing. It creates a conflict of interest for the appraiser.The appraiser has an incentive to come up with a higher number to ensure there is additional