Watch Out!

I just received a note from a young man who has begun working for a mortgage company. I will quote directly from his letter to me, only changing the name of his company.

I'm feeling uncomfortable with the way XYZ promotes one main product, the "Interest-Only ARM Loan" based on the LIBOR index,  we market loan as the "FREEDOM CHOICE" loan, as your book points out, we're using that programatis strategy.  I guess it does work.  Why am I feeling uncomfortable? 

1. The other Acct Reps (11) or so that are training with me, are as inexperienced as I am.

2. We're being trained to push one product: the interest-only loan and we are to introduce the 1-month

ARM on this product, which is now at 3.88. 

3. XYZ appears to have very high turn-over.  

4. When I raise questions, i.e. "worse-case scenarios", training manager is brushing off my questions and reiterates the stability of the LIBOR.

I’m sure that this young man’s experience is being replicated in mortgage companies all across the country that are hiring and training young men and women to become Loan Officers. Here’s what is going on.

You will recall that in the past I have warned about interest only loans, the current loan du jour, as I like to call it. Another similar counterpart, also frequently referred to as a CHOICE loan, one where your payment rate starts out at an artificially low level, even 1 percent is nothing more than a re-naming of the Negative Amortization Loan, a loan that has been around for 25 years.

In both loans you have the “choice” of making any payment you want as long as it’s more than the obligatory payment. In a neg-am loan, that is even less than interest only.

When the actual payment is less than the interest due, the difference is added onto the principal. Five years from now, your higher loan has eaten away at your equity. When you want to refinance, your options will be fewer and if you were to sell, you’d get less out of the sale.

In the case of the interest only LIBOR loan, this is not a stable index at all. The LIBOR index is probably the most volatile of all, which means as rates go up, the rate on this loan moves the fastest, exactly the opposite of what you’d want.

Now I think that there are times and circumstances where these loans are appropriate, mostly for people who aren’t going to be in a home for long time. But for the average homeowner, the long-term rate risk is, in my humble opinion, greater than the satisfaction of a lower monthly obligation.

Note that the appeal of these two loan products is that, relative to other product types, they have much lower monthly payments. And stupid American consumers who look only at the initial price of things, are getting schnookered into taking these loans. I get just as many e-mail offers as you do, and my mailbox has the same type of flyers and letters you get. Every single one of the ones I get talk about only one thing: lower monthly payment. Those ads must be working on someone or we wouldn’t get them.

And now you have information from a young man who wants to help his clients, but who has been told to sell this one type of loan. He’s being taught to sell what his company correctly perceives as one that will meet little resistance from consumers.

You know that all these companies are talking to tens of thousands of people every day and thousands of them are taking these loans, to their regret.

I hope that you will send this article to friends of yours to warn them about this.

Be careful out there.