Wednesday, May 2, 2007

Mortgage Scams

To understand the scam that is perpetrated by the mortgage specialists one doesn't have to go far. Just today I was talking to a mortgage agent regarding the mortgage on my home. I have a mortgage that is 5/1 ARM, in other words, after five years it will change to a floating interest rate which could lead to higher interest I pay on the loan.

At first she wanted to know if I want to take out additional money from the value of the home. I explained to her that my intention is to reduce my risk exposure, I don't need any additional money at this time. After collecting some of my personal details, she came back with, what she thought of as a very attractive package. She said, she will reduce my monthly payment by 40%! She said I can choose one of the four options: 30 year fixed, 15 year fixed, Interest Only and Minimum. She was offering me the "minimum" and I asked her what she meant. She said, instead of making me pay all the interest upfront, they backload the loan so that I only pay the minimum. So I asked her, what happens to all the interest and the principal I have not paid if I were to close the loan, say in two years after sellign my house. She skirted the topic. Then I asked her to send me the details. She did, then it became clear to me. Here is how it works:

Let's say I owe the bank, 1000 dollars.

30 years fixed: I pay a fixed amount every month, say 5 dollars, out of which 4 dollars will go towards the interest and the remaining towards paying off my debt. Because at the end of the month 1, I have paid off $1, my debt now stands at 999 and not 1000, so my interest next month will be slightly lower and debt repayment slightly higher. This will I keep reducing my debt and in 30 years, it will be fully paid.

15 years fixed: Same as 30 years fixed, except I will pay more per month, say 7 dollars, so that my debt is paid off more quickly. Also note that I am paying much less interest overall, because I have paid off the debt faster, even though I am paying more money per month.

Interest only: I only pay 4 dollars, which is the interest I owe on the loan, keeping the 1 dollar to myself. In this fashion, the debt is not being repaid at all and hence end up paying more interest overall. In other words I am not saving anything for the future.

Minimum interest: This is probably the worst case scenario. Here I am only paying 3 dollars, instead of 5, thereby adding more to the debt. Why? Because the actual interest is 4 dollars, and because I am not paying all of it, 1 dollar gets added to my debt at the end of the first month making it 1001, and increasing it even more at the end of second month and so on. In other words, I am borrowing even more, and what is worse, the interest rate is not fixed. It can fluctuate, increasing my risk even more.

I am a conservative investor and spender. So, I said "no, thanks" to her and asked to provide the best 30 year fixed rate.



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