Borrower Beware

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I wasn’t planning this post to be part of my debt series but when I saw the front page of the Seattle Times this morning…the timing is uncanny.   Borrower, beware:  debt disaster looms as rates rise on easy-money.   

This is a tale of a couple who was turned down my many mortgage lenders for zero down financing because they had no savings and $20,000 in credit card debt.  They are a common portrait of a subprime home buyer over the past 2-3 years.

I have issues with both their loan originator AND the subprime borrowers in this report.   

"The couple signed two mortgages to buy their $246,800 house in July. The first loan, a so-called pick-a-payment loan for 80 percent of the deal, had a variable interest rate. The second mortgage, at 12.5 percent interest, covered the rest. The deal included a pre-payment penalty on the first mortgage, and a balloon payment on the second.

Not long after they signed the loan, [the home buyer] decided to dump her sedentary office job to become a personal fitness trainer. The new job paid less, $7.89 an hour, but she had the opportunity to earn commissions as she brought in clients."

There is nothing wrong with an 80/20 subprime mortgage when it’s structured correctly and the clients understand that they have 2-3 years to prepare for refinancing.   This means they need to improve their credit scores (having a mortgage paid on time helps credit scores) and to reduce frivolous spending.   They need to be accountable and take a hard look at themselves and their finances.   Switching from a fixed income, even if it’s a boring job, to a new career that pays commission is irresponsible as a brand new home owner.

The pick a payment program is negative amortization and is not the best program for anyone with 100% financing, let alone a subprime borrower.    In fact, it’s probably the worse program a first time home buyer (subprime or not) could have.    They will 9 times out of 10 opt for the lower (deferred interest) payment and not fully grasp what the consequence are when their mortgage recasts at the higher rate and fully amortized payment.

"I had no idea the interest was going to climb like it is — they didn’t tell us that at all," Fultz insisted. "Maybe I wasn’t listening. Maybe I’m not good at words. Negative amortization? I never even heard of that."

Their Loan Originator’s response to this (you might to sit down and put away any sharp objects before you read this): 

"I agree, it isn’t explaining it in full… But…it’s explained to the client 47,000 freaking times."

And to top it all off, the Loan Originator, who’s business primarily consist of feasting on subprime buyers says she can’t make her mortgage payments now due to the decline in the subprime market.

The pullback has cratered the business model for brokers like Mills. She used to write 10 to 15 loans a month. In March, she wrote two. In February? None.

"I didn’t make my own mortgage payment this month," [the LO] said in April. "But nobody feels sorry for me."

Oh boy…someone pass me a hanky!  This Loan Originator closes 10-15 deals typically a month and I’ll eat a shoe if she’s not making more than 1.5% on each transaction.   And a few tight months SHE’s missing her mortgage payment?   

Please work with a professional Mortgage Planner.   And not the first person who tells you "yes".    That type of LO smells your desire to own a home and will take you to the bank.   And they will not be there for you after closing…unless you want a new mortgage! 

Buyer beware, indeed.

Related post:  The Debt Disease:  Dollar Buy Dollar

Comments

  1. Hi there.

    I’m really not certain who is worse in this case. Borrowers claim (B.S.) they didn’t know the terms. LO’s claim the borrowers are “challenging or high maintenance,” and they were aware of the financing terms.

    Some people just don’t have a good grasp of financial management and the money LO’s make off of these deals “lends” itself to getting the deal done knowing the borrowers will probably default.

  2. Hi Tim, the whole story just reeks! This is the old 80/20 rule and this story is the 20% of what we’re going to be reading about with the “subprime meltdown”.

    There are no bad mortgage programs. Even the option arm is acceptable for the right borrower and situation (which is rare IMHO so I am opposed to that program). This is why people need to work with Mortgage Professionals who provide knowledgable advise.

    Generally LOs do make more $$ on subprime mortgages. When ever I would price out a subprime mortgage with our reps (we broker subprime vs. keeping it on our line) the reps would tell me I wasn’t making enough “on the back end”…I’d always reply that I like my sleep! Plus, if you do your job right, your client returns to you when it’s time to help place them in a long term mortgage.

  3. richard says:

    On one hand, this couple is screwed. On the other, by buying a home they’re helping keep home price appreciation high so someone else is able to refinance out of debt.

    Let’s not kid ourselves. Alot of other people would have faced bankruptcy if it weren’t for their home appreciating enough for them to restructure consumer debt and take out cash.

    Just because these people were unlucky enough to buy further into the credit cycle is no reason to feel sorry for them. If they’d bought in 2003, it’s entirely possible that they could have dropped to a single income and both be driving new cars, paid for with home equity withdrawls.

    They gambled and lost.

  4. People BELIEVE they are reducing debt by refinancing! Reducing debt is paying down principal or paying off debt completely.

    The traditional refinance candidates were people who WERE obtaining a lower interest rate, but didn’t use the refinance to INCREASE their base loan amount.

    Today, people tend to refinance to help put a band-aid on excessive consumer revolving debt (Hummers, vacations, etc..)and shift the debt to the housing piggy bank. Problems only become pronounced when housing markets become flat or decrease in value.

    I can’t tell you how many times I sit across from a borrower who says “whew! Glad we eliminated that truck/Hummer/Boat/Bling Bling debt. I’m sitting there looking at $2000 in junk fees, a YSP of $4000 and paying off about $22K in credit cards.

    Yup,guess you just paid off that debt!

  5. Rhonda:

    Thanks for linking to my recent post. You probably know what I am going to say about your post…..

    In thinking about this “issue” we have of doing things and making decisions because we can, it is addictive. Who is “the problem”: the addict or the drug seller? The temptation to choose a financially bad program becomes too great. Yes, I would really like to be a part of some program to help people think about making home loan decisions. The messages that you and others are now making, through various blog posts, can only help people recognize and discuss and hopefully influence their choices in positive ways.

  6. Rhonda,
    I’m with you. I’d like to see the actual loan initiation rates. It’s very common for sub prime lenders to charge huge loan initiation rates. It’s sad. The people who need the help and counsel are the people who get taken advantage of. Now, some argue that the
    Buyers put themelves in their own hole and they should be “lucky” that they can get the money. Well, when the LO charges OVER 1.5%, that money comes at too high a price. Of course, the justification we always hear is that it was a “harder” loan to do. I’m sorry, it’s not worth up to twice as much!

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