Odd Ducks and Mortgage Products That Suck.

If it looks to good to be true, It is.

Now is the time to tread very carefully when selecting your next home loan.  Home prices continue to rise, pushing the outer edge of the "affordability envelope" for many prospective homeowners in many markets.  Meanwhile, mortgage companies are faced with the end of the refinance-fueled boom and the prospect of higher rates squeezing profits. 

The convergence of these two factors has resulted in a number of new mortgage products designed to simultaneously make home ownership more affordable, and edge out competitors in what is expected to be a shrinking market for new mortgages. The problem is, these new loans pose a good deal more risk to the homeowner than the more traditional mortgage loan.

To be fair, some of these newer loans fill a legitimate need. Home ownership is still the average persons best wealth building engine and buyers have been squeezed by the tremendous rise in prices (40-50% over the last 5 years in the Twin Cities alone) over the last few years. But these new loans are not without risks and should be considered very carefully. In many cases the risks and additional costs outweigh the often short-term benefits.

Here's a quick breakdown of some of the new (or not-so-new-but-re-packaged-with-a-slick-promo) mortgage programs, and their pitfalls, that most of us would do well to avoid. 

Zero Percent Interest
That's right. Zero Percent financing is not just for your new car anymore.  Quicken Home Loans brings us the "Take Six" Program.

The Pitch: Take six months off! Virtually Eliminate Your Mortgage Payment for 6 months by paying "start rate" of .03%!

The Catch: Sure, your payment on a $200,000 loan will be $5.00/mo for the first six months, but you have to pay or finance 2.25 "points" up front (for those keeping track that's $4,500.00 in addition to the other standard fees.) Oh yes, and your rate will adjust every six months (LIBOR + 2%), but don't worry about that because you only have to pay the interest.  Good Luck with this one.

The 40 Year Mortgage
If 30 is good, why not 40?  These have been around for a while, but as pointed out by Chuck Jaffe at CBSmarketwatch.com in his "Stupid Investment of the Week" column, Fannie Mae is injecting new life into these loans, offering them in test markets around the US as part of a pilot program.

The Pitch:  Lower that monthly payment by extending the term for an additional ten years.  Most homeowners only keep a mortgage for 5-7 years, so that loooooong term won't make any difference, right?

The Catch: The additional ten years doesn't drop that payment by much, especially when you factor in the .25% higher rate that 40 year loans require.  Factor in the additional interest over the life of the loan and one quickly realizes that there are better ways to lower the monthly payment ( a 5 or 7 year ARM for example) than stretching out the term to 40 years. Pass.

The "Option" ARM
These have also been around for a while, and come in many shapes and sizes.

The Pitch: Every month, you have 4 different payment options.  You can send in a standard 30 year or 15 year payment (options 1 & 2), you can send in Interest only, or you can send in a "minimum" payment which results in an increase in your loan size.

The Catch: If you take away the fact that these loans are typically ARMS that adjust monthly (interest rate risk anyone?), carry high fees, prepayment penalties (in most cases) and can result in your loan getting bigger over time, they'd be a great deal.

A Final Note

This is not to say that the programs above are universally bad for every situation.  There are scenarios in which each of the above loans would make sense, but they are unique, fairly rare and require a lot of financial discipline. All of them carry significant risks that many lenders fail to properly point out or the average consumer fails to recognize while low payments are being dangled before their eyes.  Again, tread carefully, and ask yourself: Are you willing to bet your house on it?

Linklube
Stupid Investment of The Week [CBSmarketwatch]
Another Odd One: Home Loans for Charity [Mortgagesblog]
Are No-Interest Offers as Good as They Sound? [RealEstateJournal.com]
The British Can Borrow 130% of their Property's Value [Citiwire.com (UK)]
Low Payment Mortgages Can Take off Quick [Washington Post]

01/18/05 at 07:32 AM | Permalink