Monday, October 22, 2007

The Neg-Am Scam

The Neg-Am Scam.
Guess What? Many brokers are out to get paid, and screw you over as hard as possible. Brokers have incentives that pay them money, to stick you in adjustable loans with prepayment penalties. Lenders were paying 3 to 4% rebates to brokers to sell Neg-Ams with 3 year prepay penalties.

For the past few years mortgage brokers and lenders have been shoving neg-am loans down borrower's throats at an alarming rate. These complicated loans were meant for sophisticated borrowers, who have irregular cash flows. The purpose of the loan is to add flexibility in payment options, so borrowers, such as sales people, who have fluctuating incomes, can make reduced payments and not incur mortgage lates when they have a down income month. The problem is, greedy bastards out there saw how easy it is to sell a low payment option to uneducated borrowers, and started hawking them like they were the best thing in the world for people. Guess what? Neg-ams are not the best thing in the world for everyone. In fact they can be the worst thing in the world. I explain neg ams in another post, but the bottom line is you can end up owing up to 125% of what you actually borrowed. Here is the math, on a typical scenario. Let’s say you borrow $400,000 to buy a $450,000 condo in San Jose and you are putting $50,000 as a down payment. If you take a Neg-Am, instead of more conventional financing, and make the minimum payment, you could actually owe $5oo,000 on the condo you bought for $450,000. The way a neg am works is it allows you to pay less than interest only payments, in effect adding more money to your initial loan amount, or "principal".

In reality you have the option of getting many different types of loans, but for simplicity let’s say these are the only options.

1: 30 year fixed rate
2: 5 year fixed (Fixed for 5 years, then goes adjustable)
3: Adjustable loan (adjusts monthly based on an index)
4: Neg- Am (Pick-a-pay, 4 payment options including a less than interest only payment)

A good broker would lay out all the options, and explain the differences or each. For example, the 30 year will have a higher interest rate than all the option, but the rate will never change and in 30 years you will have paid off your home, while the 5 year has a lower rate and payment now, but will become adjustable in 5 years and your payment could be higher.

A bad broker would only tell you about the options he wants you to choose, because a) he only thinks you will take it if the payment is really low, or b) he wants to steer you in the direction of the option that will net him the most money. Cha Ching! That is the bottom line, a bad broker is only out to get paid now, and doesn’t give a crap about you!

Hey, here's another little sneaky secret. Neg-ams make the most money for brokers. In the height of the real estate boom, brokers were getting paid up to 4% from banks to put borrowers in Neg-Ams. That’s right, the riskier the loan, the more the bank was willing to pay, because the actual interest rates are much higher than they would receive on a fixed loan.

Make sure you don’t get ripped off by the "financial expert" you trust.

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