Five Ways Lenders Try To Take You For a Ride
There are literally, thousands of different types of mortgages available. How do you know if your lenders are trying to fit you for the mortgage that's best for you, or if they're just looking to make some extra bucks? Here are a few ways lenders could pad their bottom lines at the possible expense of yours.
1. A $400,000 mortgage with a $1,199 payment.
If you find a $400,000 mortgage that only requires a $1,199 monthly payment and the term of this mortgage is for 30 years, you have found a negative amortization mortgage. With this particular negative amortization mortgage, you will be paying a 1/2% interest rate for the negative amortization part of the mortgage. This part of the mortgage usually lasts between 3 to 5 years. Then the mortgage converts to a mortgage with a regular interest rate. For this example, let's say the negative amortization lasts for 3 years and the regular interest rate will be 6.75%.
During the first 3 years, you will have a shortfall of 6.25% each year. This means your principal will be growing because the interest you're not paying during this time will be added to it.
In this particular case, after three years your principal will be $441,890.34. Then, when your regular interest rate of 6.75% takes effect; your payment will become $2,967.19 each month for the remaining 27 years of the mortgage.
Lenders like negative amortization mortgages, because a lot more people will qualify for larger mortgages than would have without the negative amortization mortgage. So this type of mortgage is good for them, but it could be hazardous to the borrower.
Before you agree to a large mortgage with a small monthly payment make sure the payment never changes and if it does make sure it will change to an amount you will be able to pay. Find out all the details in advance.
2. A refinance for just enough, with a HELOC added.
Many times a homeowner would like to refinance his or her mortgage and pay off all his or her bills; the lender may lend this borrower just enough money to do this. Then the lender will sell the borrower on an idea of taking on a Home Equity Line of Credit or HELOC. Usually, it isn't long before the borrower starts to use the Home Equity Line of Credit.
The problem is a Home Equity Line of Credit is an adjustable-rate mortgage. The mortgage rate can change to a much higher rate in any amount of time. Most times, it will have an overall lifetime cap that will prevent it from going over more than 12% higher than the original rate.
This type of arrangement doesn't make sense to me because; why would you want to pay a potentially much higher interest rate on a mortgage you could have locked in to a low rate in the beginning?
If you can get a refinance at a low fixed interest rate like, 6%, you should take it, and if you're equity allows, borrow an additional $20,000 to $30,000 and put it into a savings account. This would make more sense than being forced to borrow it later at a rate that might be as high as 18%.
3. A biweekly payment plan.
A biweekly payment plan gives the illusion that a borrower is paying off his or her mortgage years sooner without making additional monthly payments. After studying the biweekly payment plan, you will see this isn't what happens.
With a monthly payment plan, a borrower may be paying $2,000 a month. With the same amount of money borrowed, at the same interest rate, with the same term, a biweekly plan would require a $1,000 payment every two weeks.
With this biweekly payment plan, the mortgage will be paid off much sooner, sometimes, as much as seven years sooner. Lenders try to give the impression the biweekly payment plan has some sort of magic, but all that is really happening is the borrower is paying more money toward his principal on a yearly basis.
If a borrower pays $2,000 each month, he is paying $24,000 each year. Because there are 26 biweekly periods in a year, when a borrower pays $1,000 biweekly, he is paying $26,000 each year. Paying $2,000 more toward the principal each year, is the same as paying approximately $167 more per month. If our borrower paid $2,167 each month, he would pay off his loan at the same time as if he had paid $1,000 every two weeks.
So, what's the problem? The problem is some mortgage companies charge big bucks for converting regular mortgages to biweekly payment plans. Now, you don't need to pay to have someone implement a biweekly payment plan for you because you know how to implement essentially the same plan yourself for free.
4. A 40-year mortgage.
If a person were to borrow $200,000 at 6.75% over 30 years, his or her payment will be $1,297.20 per month. After 25 years, this person will still owe $65,902.84 on the mortgage. After the mortgage has been paid in full, he or she will have paid $266,991.98 in interest over the course of 30 years.
If a person were to borrow $200,000 at 6.75% over 40 years his or her payment would be $1,206.71 a month. After 25 years this person would still owe $136,365.76 on the 40-year mortgage. The total amount of interest he or she would have paid over 40 years would be $379,220.74.
I'll bet all lenders wish that everyone would convert to a 40-year mortgage. They could make an extra $100,000 or so on each one of their mortgages.
It is natural to be attracted to a smaller monthly payment, like the one you would get in a 40-year mortgage, but before you sign on the dotted line for a 40-year mortgage, make sure you realize you will be paying a lot of extra interest.
5. Interest only payments
Interest only payments are what you typically pay in the early years of a Home Equity Line of Credit. If you have a Home Equity Line of Credit, please find out if you're only paying interest on it. If you are only paying interest, your loan will never be paid off.
With an interest only payment plan, whether you are paying for one month or 100 years, the payment will be the same. Also, at the end of the term, whether it is one month or 100 years, the amount of money you owe will be the same as the amount of money you borrowed.
It is wise to do your homework
Not all lenders are crooks. Not all borrowers are mathematically challenged. However, when a person doesn't work with mortgages all the time, it is easy for him or her to commit to a mortgage that may turn out to be a nightmare a few years down the road.
Doing your homework is critical because it will help you make the right mortgage choice. Making the wrong choice could lead to hard financial times, and in some cases, maybe even foreclosure.