Posts Tagged ‘subprime’

Things to Think About When Buying a Home

When purchasing a home, finding the right home is very important. One must consider the location in relation to not only work and shopping, but also the types of schools that are in the area. Often, this means selecting a home that is not exactly where you want, just so you can make sure your children are at the best school. While these decisions are quite important, equally important is the choice of the mortgage lender.

A mortgage is a type of loan that is used to help make it possible for people to purchase a home, even if they do not have the entire balance up front. Mortgages vary by lender and there are several different options, but the most common is the thirty year fixed rate mortgage. This means the mortgage is for a length of thirty years and the interest rate is fixed, so as long as payments are made on time, it will not change over the course of the loan.

Another popular type of mortgage is the Adjustable Rate Mortgage. Like the fixed rate, the most common length is thirty years. An adjustable rate mortgage has, as is implied by its name, an interest rate that changes over time. Usually they are described as 5 Year ARMs or 2 Year Arms, which describes how often the rate is adjusted. So, for example, in a 5 year ARM, every five years, the interest rate will be adjusted in relation to the current market. It is important to plan for it to always go up, but with the way the current financial market is, many with quality ARMS have actually seen decreases in their interest rates over the last few years.

The main advantage of an ARM is that it has a lower initial interest rate, but it is important to understand the terms of the loan. Some things to watch out for are early pay off penalties and rates that can be adjusted by more than 1% at a time. Adjustable Rate Mortgages have gotten a bad rap, in part because many of those offered during the buildup to the financial meltdown were actually subprime adjustable rate mortgages.

Finding the Best Lender

Just like finding the right location is important, it is also very important to find the right mortgage lender. Those with good credit are at a big advantage here, as they will be able to pick and choose which lender they want, with banks and lenders being motivated to get their business. However, getting a mortgage with no-credit or even bad credit is also possible, but it is essential to avoid predatory lenders, who offer subprime mortgages to those who don’t have many options.

The best place to start looking for a loan is your local bank. This is because they already have a working relationship with you and can often provide you an answer one way or the other very quickly. Even if they turn you down, it is still a good idea to find out what types of mortgages they offer and their terms, as well as their interest rates. Most brick and mortar banks will have a very standard mortgage options, so they can be used to compare other offers to.

Once you have an idea of what your bank can offer, it is usually a good idea to speak with a mortgage broker. Mortgage brokers are basically middle-men who usually have a working relationship with several different mortgage banks. They will be able to check their resources and offer you a few different options. However, it is very important to carefully consider their options, because they only get paid if you buy a loan through them, so are motivated to make a sale.

Once you have received a few offers, don’t be in a rush to jump into a loan. Instead, carefully evaluate each mortgage, its terms, and requirements. This way, you can avoid falling into bed with a predatory lender, who offers a subprime mortgage, such as having an early payoff penalty.

Subprime Mortgages: Negative Amortization Loans

There are many types of subprime mortgages, but one of the most predatory types of mortgages is the Negative Amortization Loan. Negative Amortization Loans can sound attractive at first, but after a few years, it is very easy to end up owing more money on your mortgage than you initially paid.

In a negative Amortization Loan, the monthly payment is less than the total amount of interest owed for that period of time. This difference is then added back onto the loan, which raises the total amount of money that is owed to the mortgage lender.

Negative Amortization Loans are sometimes called a deferred interest loan, Graduated Payment Mortgage(GPM,) or NegAm Mortgage. No matter what the name, if you are paying less than the normal amortization amount every month, you are in a very dangerous position.

How Normal Amortization Works

Amortization is used to refer to how the payments of a loan will be used to pay down a mortgage. During normal amortization, part of your payment goes toward the interest of a loan and part of it goes towards the principal of the loan.

At first, more of each payment goes towards interest than principal, but over time, this reverses and you begin to pay more towards the principal of the home and less in interest.

To see how each of your payments are used, you can view an Amortization Table, which most lenders will freely provide you with. The Amortization Table will break down all of your payments by month, showing you how much principal you owe after each payment.

What is a Negative Amortization Loan?

A negative amortization loan is when each monthly payment is less than the total amount of interest owed on the loan. The interest that is not paid is then tacked onto the principal of the loan. As a result, each month that you pay negative amortization, the amount you owe on the home increases.

So, as an example, say that during the first year of a 30 year mortgage, a normal mortgage payment would be $500 a month, with $400 going towards interest. In a negative amortization loan, you might only pay $250, with $250 getting added onto your total mortgage balance each month.

As a result, this not only increases how much you owe on the home, but it also increases the amount of interest you owe.

Due to legislation, this is usually only allowed to happen after up to five years, which is referred to as the recast period. However, in five years time, paying negative amortization can result in owing many thousands more than what you paid for the home and what it is worth, which makes selling the home very difficult.

Dangers of a Negative Amortization Mortgage

Many people who have negative amortization loans end up short selling, which means selling the home for less than they owe. This is because the principal of the loan vastly exceeds the homes actual value, which is referred to as being underwater on a loan.

When negative amortization loans are coupled with an adjustable rate mortgage, which has an increasing interest rate every few years, it is very easy to end up underwater on the loan. When the adjustable rate increases, which it will, this means that all of the money added on by negative amortization, will also increase.

There are many problems with negative amortization mortgages, which often result in drastic increases in mortgage payments each month. This is often referred to as payment shock, where the amount owed month by month can rapidly increase after the recast period.

Why Do People Use Negative Amortization Loans?

While negative amortization loans can be very dangerous, if you plan on quickly selling a home for a profit, it can be a good investment tool, as you will have a lower monthly payment. However, this is very dangerous, as if you can not sell the home or if the value of the home decreases, you will end up owing more than the home is worth.

Many first time home buyers get into trouble over these types of loans, because they have a very low initial monthly payment, which can seem very attractive. However, once the grace period is over and the rate increases, they soon realize they have entered into a predatory loan.