Learning From Others-A Cautionary Tale

Over this last weekend, I did a fund-raising charity ride for the
benefit of United Cerebral Palsy in San Diego. At dinner on
Saturday I was talking with another rider and when she
found out that I was a mortgage broker, she asked me a
number of questions and I learned about her current predicament.
She had worked through another mortgage originator previously.

She has had her existing loan for about a year and a half. She
discovered, too late, that it was one that allowed for deferred
interest or "negative amortization". This loan was a refinance
due to a divorce situation, so she pulled cash out of the prop-
erty to pay off her former spouse.

At that time, she financed 90% of the value of the home, and
she was qualified based on the "stated income" program.
She had a strong credit history and credit score, but limited
savings or retirement funds, so she needed every advantage
to qualify for the new loan and keep her condominium for
herself and her two children.

And, in the "Add Insult to Injury" Department, she also has
a prepayment penalty on the loan that was not made clear
to her.

She could be the Poster Girl for the current excesses that
have taken place in liberal underwriting and approvals, and
also how misplaced trust in financial advisors can create
bigger problems.

Let's look closely at some of these details.

First, she was emotionally attached to wanting to keep her
condominium for comfort and security and that framed her
decision-making at every turn. She never seriously considered
selling the home and splitting the proceeds with her former
spouse because she didn't want to rent or downsize to a
smaller place.

Second, the low payments that the deferred interest option
loan offered were very attractive to her, and were affordable.
Although she seemed to recall having some of the conse-
quences of that loan explained to her, she never thoroughly
understood how it worked.

When she got the loan, the amount of interest deferral was
modest, but as interest rates have increased over the last
year and a half, she is looking at her loan balance increasing
significantly each month.

The loan allows for the principal balance to increase no higher
than 110% of the original loan amount. When the loan began
the projection was that it would not happen for many years,
but with the higher interest deferral she may be facing signi-
ficantly higher payments within the next year.

Third, she obtained her loan, and bought out her ex-husband
near the top of the real estate market. Property values have
dropped, and combined with her loan balance increasing, her
equity is being squeezed very close to nothing.

Fourth, by relying on the "stated income" qualifying feature,
she allowed herself to be put into a situation that could become
increasingly unaffordable. I did not get all the details of what
she really made versus what was represented on her loan
submission, but she may have been optimistic about having
additional income that did not come to fruition.

Lastly, the prepayment penalty handcuffs her to the existing
loan unless she wants to pay thousands of dollars to get out
of it. Of course, she does not have the equity in the property
or the cash in reserves to absorb this kind of expense.

What can we learn from her ordeal?

A. Seek out many solutions to the problem and don't rule out
any of them until you have a chance to assess the merits
of all of them.

There is a saying that when your only tool is a hammer,
you treat everything like a nail. But be cautious that the
person from whom you are seeking advice is helping you
brainstorm solutions to your problem and not just promoting
their product.

In too many cases, if you speak with a real estate agent,
they will want you to list the house with them. If you speak
with a mortgage originator, they want to sell you a new loan.
But there are quality professionals in both industries that will
give you honest advice and resources to explore to make sure
that you are well-cared for.

B. Thoroughly understand why the proposal that is being
offered is good for you, and take the time to understand the
details.

I know that the mortgage business can be confusing, and some
originators are not that great on explaining the features without
using verbal shorthand, but you have to insist that they keep
explaining it until you understand it properly. If they are unable
to communicate to you effectively, you should find someone
who can. The consequences of misunderstandings or failure
to disclose pertinent terms to you are just too expensive in
both dollars and emotional distress.

C. Forecast what the "worst-case scenario" is, especially if
you are considering an adjustable rate loan. We can make
projections based on reasonable assumptions but insist on
knowing how the loan performs if everything goes crazy.
That is the only way that you can satisfy yourself that you
have a plan that can work for you no matter what.

I know that I keep repeating this, but it is important that you
find the right people to counsel you, and who are truly looking
out for you best interests.

If she comes to me to help brainstorm a solution to her
problem, I will do my best to help her, irrespective of whether
it creates a new loan for me or not.

When you come to me for help, advice, or mortgage services
you can be confident that I will do the same for you.