JAMES B. NUTTER JR.
PUBLICATION: Kansas City Star, The (MO)
DATE: July 12, 2005
Today’s interest rate - between 5 percent and 5.5 percent on a 30-year fixed-rate mortgage loan - is remarkably low by historical standards. Yet there is a disturbing trend among some lenders to push the envelope by offering what we call “teaser” rates of 1.5 percent or 1 percent interest on a mortgage.
Here’s just one example of offers that have found their way around my spam blocker recently: “$230,000 home loans are available for only $340/month! We’re practically giving away money!”
Are they really giving money away? Of course not.
The people who advertise these extraordinarily low rates have absolutely no intention of losing money. In fact, they make five or six times more per loan than a lender providing conforming loans.
Here’s how teaser rates work: A mortgage broker, or possibly even a large national lender, grabs you with an unbelievably low rate of, say, 1 percent or 1.5 percent. And you actually do get that low rate - for exactly one month. Then it jumps up. In effect, what you’re getting is a one-month adjustable-rate mortgage.
After that first month, they may offer you the option to continue making payments calculated at 1.5 percent. But your entire loan balance will then be hitched to a high-end “market rate” of 5.5 percent or 6 percent, well above the current standard rate. In other words, the amount you think you’re saving every month is actually being loaded onto the back of your loan.
Ongoing house payments calculated at 1.5 percent may “save” you $500 a month on a $150,000 loan, but after one payment your loan balance will go up $500, to $150,500. This happens every month that you get that teaser rate. This is called negative amortization.
I’m willing to bet that nine out of 10 people who sign up for this deal have no idea that they’re paying so much extra in the long run.
And these hungry lenders are not done with you. At closing, many charge 2 discount points plus an assortment of “junk fees.” Two discount points on a $150,000 mortgage amount to $3,000. When you start adding junk fees, which usually average $1,500 to $2,000, you’re paying anywhere from $4,000 to $5,000 for the privilege of getting that smoke-and-mirrors 1.5 percent interest rate for a whopping one month.
What’s scary is how popular these deals have become. Right now these lenders say they do, on average, $25 billion to $30 billion of these each month, and that figure is sure to keep increasing. For instance, I know of one national lender that was not doing any of these loans in January. By April, they closed $1.3 billion worth of them. This market would not be growing so rapidly if the lenders weren’t making money - and if borrowers weren’t falling for teaser rates.
I truly believe that the main reason this loan was developed was not only to get business, but also to confuse and even trick people. In fact, recently The Wall Street Journal investigated the practice and warned that the risks can be considerable, and aren’t always understood. Federal Reserve Chairman Alan Greenspan also has expressed concern about these kinds of loans, which he calls “exotic mortgages.”
Unfortunately, the people who get burned the most are probably the families that can least afford it - lower-income families, families trying to get by, families trying to keep their homes, families trying to get into a home they may not be able to afford - which is doing them a horrible disservice.
With fixed rates as low as they are now, you don’t have to have perfect credit to qualify for a legitimate home loan.
So if you’re offered a far-below-market interest rate, remember what parents have been telling their kids for generations: If something looks too good to be true, that’s because it is.