Bank rewards Sale of “Risky Mortgages”
Several times over the past few days I have noticed this headline. The basic story here is that Wachovia, a Charlotte NC based lender is paying their loan officers additional incentives for selling their “Pick a Payment” mortgage program.
The “Pick a Payment” mortgage loan has been the staple loan of World Savings Bank, now owned by Wachovia. This loan offers the borrower several payment options, including one that leads to “negative amortization.” And in light of today’s declining market and the negative press the entire mortgage industry has endured, this certainly makes for great headlines. The problem is that the news media fails to fully explain this mortgage loan, similar to how some not so “above the board” mortgage brokers and lenders failed to explain it to their clients.
This “Pick a Payment” mortgage loan has many names. One lender also called it “Many Options.” The premise is that you have 3 basic payment options each month:
- Full Principal and Interest: This is what most people are used to. Each payment sent in pays the interest for the loan, plus a portion of the mortgage balance and will eventually lead to the mortgage’s full repayment.
- Interest Only Payment: This option allows the borrower to simply pay only the interest due on the mortgage each month. By choosing this option, the balance of the mortgage remains unchanged and nothing is paid to the balance. However, any interest only mortgage loan limits the number of years one can only pay the interest. The remaining years will then be full principal and interest to pay off the mortgage loan. This often leads to a higher payment.
- Minimum Payment: This is where the loan gets more complicated. Each month a borrower would be able to make a payment that did not cover all of the interest due on the mortgage loan. The remaining deficit of the payment was added to the balance of the loan, causing “negative amortization” (the loan balance grows instead of shrinking.) Every year the minimum payment would increase requiring a slightly higher minimum payment, until either the minimum payment matched the interest only payment or the loan balance had increased to a maximum level, typically 10-15% above the original balance. (Example: Original balance is $200,000. The maximum the loan could grow to would be $220,000 at a 10% cap at which time the minimum payment would go away)
For MOST borrowers, this “minimum payment” is NOT a good option to have. Don’t get me wrong, for the right client AND the right property, this can be an amazing program! But as credit guidelines and “layered risking” continued to loosen over the past few years, this product was advertised in misleading ways and was sold to the wrong borrowers.
The right client is one that is financially sound and savy. The right borrower is one that would take the money saved each month from the difference in payments and properly invest it, or reduce other debts. The right property is one that had a strong track record for increasing in value (appreciation) and had a large amount of equity already in it (15-20%). So the idea is that with the right investments one would make more money each month than the interest on the mortgage costs them, and with the home’s equity and appreciation, even adding the 10-15% on top of the loan balance, the total mortgage balance would always be well below the value of the property. This would prevent someone from owing more on their home than it was worth, even in a “declining market.”
The wrong borrower is the one that was seeking the lowest payment they could get for the largest home they could afford. Or the one that had “good intentions” for investing, but found other places to spend the monthly savings. The wrong home was something in the starter home market and first “move up” home market. These types of properties are impacted more by “declining markets” than your upper end homes, be that fair or not. The other type of home that was wrong for this property was a home with little equity. In many cases, this loan required an equity position to offer it, but it was also sold by some lenders with a second mortgage that ate up that equity. The end result was a mortgage balance that ballooned above the value of the home. And in today’s soft markets across the nation… well, that’s just not a good thing.
The reason Wachovia offers higher incentives to their loan officers for selling this is because it is a tricky mortgage loan to explain! It takes someone that understands the potential and the risks, and the loan officer must make a sound decision as to the aptitude of the borrower before offering. The danger is that, as in the past, the incentive could lead to short cuts in explaining just to get the extra bonus in one’s paycheck. This is something Wachovia will have to monitor closely.
In my humble opinion, this type of loan is a great option for those that can understand it’s complexities. When I personally offer this mortgage loan to a client, I offer warnings and fully explain all options. But that is my job… to fully explain and educate my clients about something as important as their mortgage!
I was sold this loan and I did not have the priviledge of working with an integrity based mortgage officer. They sold me a bag of goods, and later explained that I would not have been approved if it were not for this type of mortgage.
The sad part of the mortgage fiasco is innocent people got hurt trying to own a piece of the American Dream. The dream has now become a night mare and to that end we are faced with pain that only time can heal.
I pray that I get out of this mess with as few bruises as possible.
@Vickie: I am sorry to hear about your situation. Unfortunately, you are not the only story like this. Many people have had similar experiences. My hope is that when this all settles, we as Americans learn from this and work hard to prevent it again, while limiting government interference.
Too many programs that lead us here were imposed by the government to begin with. At first these programs appeared to be profitable and so more and more lenders jumped in. More and more loan officers sold the loans, many without ever explaining the possible end results to the one taking out the mortgage.
I wish you well.