Question: I read your column about false advertising and want to share my story and ask for advice. We own a home in California and had a $450,000, 5.50 percent, interest only mortgage. We were easily making the interest only payments and thought our payments would drop next year.
A loan agent contacted us and we ended up refinancing this loan to a new loan with negative amortization with a rate of 1.45 percent. The new balance is $453,000 and the minimum payment is $1,154. The loan agent said that making the minimum payment would increase our mortgage balance by $36,000 over the next three years.
After making the first two payments, we noticed that our mortgage balance was increasing by $2,000 each month. If this continues, our balance at the end of three years will increase by $75,000, not the $36,000 that was promised. We also thought that our index was fixed at 4.50 percent but have since found out that the index can increase.
There is a prepayment penalty of 15 percent in the first year, ten percent if we refinance in year two, and five percent in year three.
We both have good, steady jobs and could easily have afforded to continue to pay interest only at 5.50 percent. Can you please advise us as to how to get out of this situation?
Answer: Well, this is a tough one, and it sounds more like a legal issue than anything else and I'm not qualified to write on legal issues, but I'm happy to give you my thoughts. The first thing you need to do is obtain copies of all documents and disclosures that you signed at the time of loan application and at settlement. If you signed disclosures that explain the terms of the loan at the time of application, I'm not sure what you can do. The disclosures that you should have signed should expressly state, among other things, the following:
- The terms of the interest rate adjustment;
- The index of which the rate is tied;
- The margin, which is the fixed percentage added to the index to determine the rate at the time of adjustment;
- The payment option terms and the specific calculations on how the minimum payment (and negative amortization) is calculated;
- The terms of any prepayment penalty.
If your loan agent cannot or will not provide you with executed copies of these disclosures, you should file a complaint with the loan agent's state regulator.
Your letter is a perfect example of a homeowner taking out a complex mortgage program without having any idea of what it is or how it works. Whether or not the loan agent completely and willfully misled you is up for question. I have no idea. But if you signed documents that explain the terms of the loan, I don't know what you can do.
What's clearer is that you signed up for a loan without really knowing anything about it. Good, honest loan officers never let this happen. Here are some questions I asked myself when I read your letter.
Why did you think that your payment on a 5.50 percent interest rate, paying only interest, would drop next year? Interest rates have risen, and most interest only loans don't allow a negative amortization payment unless the product is one of the so-called option ARMs, which carry an interest rate that adjusts monthly.
The 1.45 percent rate on the new loan is most certainly a payment rate. The payment is calculated as if the actual interest rate was 1.45 percent amortized over 30 years. Using these terms with a loan amount of $453,000 would place the minimum payment closer to $1,500. I can't reconcile how the $1,154 is calculated.
If the negative amortization is adding up to the tune of $2,000 per month, your total interest charged is $2,000 more than you minimum payment. Add the minimum payment and deferred interest together, and we have a total interest charge of $3,154 per month. This equates to annual simple interest on a $453,000 loan of 8.4 percent. This number makes sense because most option ARMs are carrying a fully indexed interest rate in the range of 7.75 - 8.50 percent, depending upon the actual index and margin.
The last thing that puzzled me about your letter was that fact that you could have afforded to continue to pay the interest on your previous loan. Why did you refinance a 5.50 percent mortgage, which is well under current market rates?
It's impossible for me to make any clear conclusions. This is why it's important for you to obtain copies of all the disclosures you signed.
A few years ago I came across a situation that, on the surface, was similar to yours. The borrower complained that he was misled into an option ARM loan that contained negative amortization. But the loan officer provided me with executed disclosures that explained all the terms of the loan. The borrower not only signed the "official" lender disclosures that explain the terms in wordy legal jargon, but also simple, easy-to-read summary disclosures. These forms expressly outlined, in bold letters, negative amortization and what it means, the terms of the monthly adjustable rate, and the prepayment terms.
These were signed at the time of application, 30 days before settlement. It was concluded that the borrower had full knowledge of the program and had changed his mind as interest rates crept up.
Obtain copies of all the disclosures you signed and re-read them. If the terms explained in the forms are different from the terms of the loan, you need to pursue your situation to the state regulator and the lender who issued the loan.
Loan misrepresentation is not just unethical, it's illegal and lenders that engage in such practices need to be shut down. They give the entire industry a black eye.
