Being a professional mortgage lender and broker, I like to believe that most of us in the business are honest, reliable and knowledgeable. While this is true to a large extent, the relatively few bad guys in this business make us all look bad.
The housing market has cooled and interest rates are on the rise. What's a mortgage broker to do? Well, it's pretty clear that many of them are getting a bit more aggressive in their marketing techniques. Over the last few weeks, I decided to pay close attention to the myriad of mortgage advertisements that constantly bombarded me. If something appeared fishy, I followed up.
Lenders are heavily promoting the so-called "Option ARM." Basically, an Option ARM is a monthly adjustable mortgage that gives the borrower multiple monthly payment options. The borrower can choose between making a payment based on a 15 year amortization, a 30 year amortization, an interest only payment, or a rock bottom minimum payment that carries negative amortization. For folks who are unfamiliar, negative amortization, or "neg-am," occurs when the minimum payment does not cover the interest charged, increasing the balance every month.
I was a big fan of Option ARM programs for the first few years of this decade. Why? Not because of a negative amortization feature, but because these programs are tied to short term interest rates. From mid 2001 until mid 2005, short term rates were hovering between one and 2.50 percent, allowing a fully indexed mortgage rate of three to 4.50 percent. The rates were unbeatable.
Now that the Federal Reserve is on a rate hike campaign, these mortgage deals aren't what they used to be. Fully indexed Option ARMs carry rates in the 7.50 percent range -- more than double what they used to be. Many lenders, however, are silent about this fact when they advertise. Here's a sampling of my research.
- I receive a letter in the mail from a mortgage company that touts a debt consolidation loan with an Annual Percentage Rate (APR) of 2.40 percent. An APR is required by federal law to be disclosed on any advertisement that quotes and interest rate. I knew right away a mortgage loan with an APR of 2.40 percent didn't exist. When I called the company for clarification, they told me that the letter contained a "typo" and that the 2.40 percent was a "payment rate" that carried negative amortization. Yeah, right.
- I receive another letter from a company that says I am "part of a select group of homeowners to take part in an exclusive mortgage rate reduction program." Seeing as the interest rate on my current mortgage is 5.50 percent, far below market rates, I decided to call for more information. Sure enough, the woman on the line tells me that I was selected to take part in a payment reduction program, not interest rate reduction. It turns out that the program carried a variable rate that's fully indexed at 7.75 percent. The lower payment would have cost me $1,031 per month in negative amortization.
- I'm driving back to the office after a lunch appointment and hear a radio ad that starts out like this: "If you're paying more than 1.25 percent on your mortgage, you're paying too much." I call the advertised toll free number and pretend to be an enthusiastic prospect. I ask the fellow on the phone some detailed questions.
"Is the rate adjustable?"
"Yes, but the rate is fixed for the first five years."
"The actual interest rate is 1.25 percent for five years?"
"Yes, it a great deal"
This went on for a while. I kept offering the fellow opportunities for him to tell me that the 1.25 percent was a payment rate, not the actual interest rate. It wasn't until I identified myself as a mortgage professional and columnist when he fesses up that the product he was touting was indeed an option ARM with an interest rate of 7.50 percent.
I've got nothing against Option ARMs. They are indeed good for some folks. But the fact is that they're not a very good deal anymore for most folks because the interest rates aren't favorable compared to fixed rates.
Lenders are selling a low monthly payment. And when they sell a low payment, they must disclose that low payments have costs, such as negative amortization. The companies that advertise low payment rates as actual interest rates aren't just misleading the public, they're breaking the law.
If something sounds too good to be true, it probably is. Caveat Emptor.
