Mortgage Horror Story of the Week: Ripped off by Daughter’s Boyfriend

A Rising Tide Lifts All Boats

That was certainly true of the appreciation that carried real estate values high up the beach in the first half of this decade. However, the tide has since rolled out, exposing the rocks and broken glass on the beach and leaving many a boat on its side in the sand. This is the story of one such wreck.

A real estate agent with whom I do business called a few weeks back. She had a friend in financial trouble and wanted to bring her in for advice on her loan. The friend had refinance in 2005 into a loan that she thought was fixed but later discovered it wasn’t. She was not sure what to do.

The Patient’s Story

When the pair arrived at my office and the homeowner began describing her loan, the symptoms were unmistakable. Attracted by the incredibly low payment, she had taken what she believed was a fixed rate loan. But in the following months, she watched her interest rate climb with each new statement. Since her payment had remained fixed, she was at first confused but not overly concerned. She only began to worry in earnest when she received the announcement that her 2nd year payments were taking a jump for which she was completely unprepared.

The Diagnosis

By now, you may have guessed that she has a Pay Option ARM. Pay Option ARMs are the old “Neg Am” (negative amortization) loans with a fresh coat of paint and a spiffy new name. They sport a few new bells and whistles, but at the core, nothing has changed. In essence they take the interest-only notion one step further, allowing the borrower to pay less than the interest owed. But if you owe at 7% and pay at 1%, there is a whole bunch of interest that will be tacked on to your loan balance. And you are paying interest on the interest as well.

Why are these loans so heavily advertised right now?

• Extremely low payments relative to the loan amount
• Deceptively low “advertised” rates that hide the real interest rate
• Fixed payments that fool consumers into thinking the rate is fixed
• Many people own homes they really cannot afford
• They are easy to sell, if you don’t tell the whole story
• They are extremely profitable to the loan officer*

So how did she get into this bad deal?

While there are situations in which a Pay Option ARM makes great sense, this was not one of them. But the daughter’s fiance had recently joined the legions of still-green-behind-the-ears loan officers trained to prey on unsuspecting consumers. At the insistence of her husband and to keep the family peace, she agreed to let the young man handle the refinance. She had no idea anything was amiss until the payment increase notice arrived.

To make things worse, once in a Pay Option ARM, it can be very expensive to get out. In order to super-size their commissions, loan officers will wrap a 3–year prepayment penalty around the loan that can amount to $20,000 or more. Fortunately this client was able to handle the increased payment for a couple of years until the penalty expired, so I advised her not to refinance and to make the full interest-only payment.

Ignorance or Avarice?

I want to think that the future son-in-law’s recommendation was born of ignorance. But my wholesale reps tell of mortgage shops full of new loan officers who have flooded the business looking to make a fast buck. While the client is marvelling over their fake 1% rate, their loan officer is pocketing rebates of 3.5% in addition to the up-front fees charged. And many lenders are not required to disclose rebate. Only mortgage brokers must disclosure these fees. That’s one of several good reasons for not working directly with a Countrywide, Wells Fargo, or Ditech, where the transaction will not be as transparent.

Epilogue

I thought I had successfully dodged the issue. In the interest of family politics, I had already decided that I wasn’t going to bring it up. But as I walked her out, she screwed up her courage and hit me with the question: How much had boyfriend earned for this disservice? I had known the answer in the first few minutes of our meeting when I reviewed her refinance paperwork. About $16,000 I replied. I won’t soon forget the look on her face.

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