Wachovia recently announced it will no longer offer negative amortization loans, despite their investment of $24 Billion two years ago to buy Golden West, who had “neg am” loans as one if its primary product offerings.
Why? Negative amortization loans don’t make sense. Nor for lenders. Not for borrowers. Not for anyone.
A negative amortization loan is one in which the borrower is not required to make payments sufficient to pay down either principal or interest. As a result, the principal balance actually grows rather than shrinks (as with a conventional amortization loan) or remains flat (as with an interest-only loan).
My first experience with a negative amortization loan was in 2002 with a real estate investment deal in Fayetteville, Georgia. I was engaged in the practice of acquiring property subject-to the existing mortgage and finding a lease-option buyer for the property, then selling both the property and the lease-option agreement to a 3rd party investor for a flat fee of approximately one year of profit from the deal.
It was great for everyone – I made a chunk of cash, the investor got a property, a tenant and usually a 100% (or better) annual return on their capital, and everybody was happy. And then one day…
…an investor here in Atlanta wanted to do one of these deals with me, but instead of sticking with the subject-to transaction I’d found, he wanted to get his own loan. I didn’t care one way or the other, but I was certainly curious why he’d do that when he had financing built-in to the deal.
His answer? “I can get a loan with a payment of about $550 per month.” My jaw hit the ground. This property had a sale price of about $360,000 so I knew a $550 payment was totally impossible without a HUGE down payment. But this guy wasn’t making a big down payment. He was using a negative amortization loan.
The deal didn’t work out with that investor, and that may be a good thing for him. If it had worked out, he’d probably be facing foreclosure today, with a principal balance far in excess of the original financed amount.
Wachovia has learned the hard way that it makes no sense whatsoever to sell financial products with which no one can win. Hopefully, we as investors have learned the same lesson: No matter how euphoric a market appears, sound decision making must rule. Greed always ends in lack.
I need my pass word.It was lost.
Just enter your name & email in the spaces in the far right side (near the top) of this page, and you’ll receive the password. — Bryan Ellis
Sorry… you’re wrong on this one. My neg am loan is awesome. Of course I know how to handle one. We pay a lot of principle when the rate is low (like now) and we cut back when rates are high. We’re coming up for our 5 year recast in a few months but tthere is nothing to worry about. Since we have made principle payments, we’ll now be re-amortized at 25 years at current rates (the MTA index is around 2% now). Add our margin of 2.5% and I’m at 4.5%. Anyone else have a rate of 4.5%?
those programs are only good for the experienced ones
The mortgage meltdown is a direct result of unscrupulous mortgage brokers offering OPTION ARM loans to owner-occupants who could only afford the minimum (negative amortizing) payment. Real estate brokers also colluded in the scam, because they were only concerned about getting paid a commission.
I actually saw a real-life example of this on a television reality show. The mortgage broker and real estate broker were sitting in a conference room with their buyer. The buyer could only afford $1600/month and the loan was for $500K (an 80% 1st and 20% 2nd). The interest-only payment was about $3200/month. The mortgage broker and real estate broker knew the buyer could not afford the loan, but they wanted to close the deal and get paid a commission. They didn’t care about the buyer defaulting later.
The OPTION ARM loan was designed for LANDLORDS of income property, not owner-occupants. The landlord charges a rent that will cover the expenses, taxes, insurance, and debt service on the 30-year amortizing payment. When there is a vacancy, the landlord can make the minimum payment or interest-only payment while the unit is vacant (usually 30 days), then go back up to the “normal” payment.
Lenders that make mortgage loans near the full retail value of property have no intention of “stealing” the property. They DO NOT WANT TO FORECLOSE. They want to earn interest and KEEP IT. Do not blame the big lenders that were deceived by mortgage brokers who falsified loan docs and real estate brokers who did not uphold their fiduciary duty to protect their clients.
Jeffery Smith, hit it really on the head!! It amazes me how many people, Professionals and otherwise, do not understand the very real benefit of negative amortization loans. They are all about cash flow.
When you hear about how bad they are it is always the same thing all about how evil some one was. It just takes very simple math to understand them and not a lot of IQ. If you are lead down the primrose path don’t be suprised by what you find at the end.
Like every loan they have there place, next thing we will hear is how bad having a hard money loan fo 12% is. Yes it would be bad if you had it for 30 years but as a bridge they are great for 6 months.
The other side of this is owning a treasury bond at 4.5%. People have been told for years what a good safe deal this is. What a pack of lies. Between inflation and taxes you are certain of losing money in real terms. Yet you don’t hear a big cry and hue to avoid them! We should, it isn’t possible to come out ahead unless you are a professional trader. Just like a professional real estate investor can come out with a ARM loan. Not good for many but it doesn’t take genius to figure that out, just some simple math.
People grow up and take resposibilty for your actions and life. It isn’t always someone esle’s fault.
Neg am loans are not new. History repeats itself. They blew up before and have again. History is repeating itself–and its damn scary.
Interest only loans are not new either.
Adj rate loans are not new either.
40 and 50 year loans are newer–here in US but not in Europe.
This was all predictable. It hasn’t been that long ago when World Savings was offering 125% loans. Many lenders were doing the 80/20′s right up until the end.
When the market escalates too quickly and the reason is due to increased speculation, it is time to take your profits and wait it out. Then try to predict the bottom of the market as best you can (more importantly, the latter portion of the bottom of the market) to maximize potential appreciation. But the problem is too many people were speculating for unreasonable appreciation, and not long-term investment based on a sound business model.
I learned this the hard way in the early 1990′s when the market took a major dump. I thought I was in a market that was resonably immune from the economic down-turns in the real estate market. Unfortunately, I had to learn this the hard way.
My first clue should have been when the janitor at the local Wal-Mart thought he was going to get rich in real estate. No disrespect to janitors, or Wal-Mart, but lets face it, this isn’t where we go for real estate advice.
Very well stated. Thank you for posting this. — Bryan Ellis
I don’t feel that this assessment of the neg-am or option arm loan is correct. This loan should have always been used as a financial tool and not a means for qualification.
This loan can be very beneficial for a borrower who is self-employed, commissioned, or has swings in income. The option arm has been around for a great deal of time (since the early 1980′s), but it was obviously not a mainstream product until a few years ago when Washington Mutual, Countrywide, ABConduit, World Savings (now Wachovia), and other large banks/wholesalers that started paying strong YSP commissions on these loans. Do I think this was a problem? Yes, I do. Do I blame the lenders? No. Do I blame the brokers who sold these loans? Some of them…
As I stated earlier, this loan does have benefit, but that benefit can turn into detriment if it is used for qualification as opposed to the best deal for the borrower. These loans in many cases were sold the wrong way. There was a different kind of benefit involved. It gave more average individuals the ability to save that would have never normally had that option. Unfortunately, many brokers and/or bankers did not explain the second step to these loans. You have to save, which means you have to be able to afford that full payment regardless of having to pay it every month or not.
I have used these loans myself; as well as, told some family, friends, and customers that this may be a good option for them. I believe in this product if it was used correctly. On the other hand, I also told others that it was not in their best interest to go into these loans.
I have always felt that these loans are geared to a specific type of customer. The loans are very beneficial if customers are able to make the full monthly payment, but as opposed to making that full monthly, they are differing the interest (with a detailed plan of how to pay it down – for example the bi-weekly) or paying the interest only payment. With the money they save between those payments, they invest the additional funds in another financial tool via their own financial planners/advisors or another outside financial consulting company. If ever my clients were unwilling or didn’t feel they needed to consult a professional when using this tool, I told them that I didn’t feel that it was in their best interest to take these loans. Most took my word on this, and or sought assistance from a financial consultant; others went elsewhere to get these loans (and many of them who did grew to regret not taking that advice).
The fall of the housing market was something that many of us saw coming, but just never in a million years expected it to be this bad. We also never figured on the enormous amount of band wagon jumpers that have gotten on the foreclosure train to get out of taken responsibility for their own actions (this includes the lending institutions who have made such serious restraints in lending guidelines, that many good potential borrowers are unable to get financed).
On a more publisized note, let’s quickly discuss the blame laid on mortgage brokers. I do believe that in every industry there are, unfortunately, unscrupulous individuals. I don’t think that the mortgage industry is any different. There were bad people out there, but, hopefully, the drought in cash flow has cleared them out. In defense of the industry, I have to say that there are a lot of good, knowledgable, caring mortgage brokers out there, but people still have to remember they always have to comprehend what they are signing. They are just as reaponsible.
I would like to end on an analogy that my financial planner always uses when talking about investment products and tools. This is one of the best analogies I have heard and it truly does paint a true picture of the misunderstanding of one of the best tools to come out of the mortgage industry in many years, the option arm. “If you put a chainsaw in a lumberjack’s hands it’s ok, but if you put that same chainsaw into a child’s hands it becomes dangerous.”
Feb. 25, 2009
Not too much has changed since July, except most of what was stated in is even more valid now.
I am really sad about what the Obamanites want to do with what is left of the real estate market. Listening to the market news this morning substantial drops in loans for last week were reported. This can be tied directly into the gigantic increase in the deficit by our current administration.
What happened to all the promises for change? I myself did not believe Obama for a minute and after watching his speech to the Congress last night, I have even more reason to not believe him.
The market is once again tanking this morning, just as it does every time he talks. His strategy for the market is to run it to zero it would appear. It is always the same lots of talk and never any detail. For such a “bright“ guy why isn’t he able to ever come up with any details? Maybe he is not so bright; maybe he is just another political stooge of the Chicago machine. Sure looked like it last night when that witch Pelosi kept bouncing around like a cheerleader.
What was that about? It is not as if he said anything new just more of the same, lots of talk, no details, no substance. Well there was one difference, he lightened up some on telling us the end of the world is near if he doesn’t get to act now. That was nice I guess.
How does he, or anyone else, think running up the largest spending ever seen going to make things better? How can the real estate market ever get better if we have a government deciding who played nice getting their loan and who didn’t play nice? Then when they decide you are one of the good guys, they will lower your loan value and loan payment. Why are investors one of the groups the government has their sights on as the bad guys?
I always thought investment was one of the hallmarks of our country. I was raised to believe you invested and lifted yourself up over your life to a better station in life. Therefore, it was possible to retire and enjoy a life of less work and more charity with your free time.
How did this become something the government should constantly denigrate repeatedly, making investors villains, making everyone connected with investing villains?
If you want to really see topsy-turvy, you need to watch the interview of an Acorn executive on Fox Business News with Stuart Varney and listen to her stating having a house is a right even if you are not paying for it.
With 2 billion dollars of our tax money given to Acorn by Obama as part of his stimulus package, they will have a lot more power going forward. That is what I want, an organization under investigation by the FBI in a dozen states for fraud, become even wealthier and powerful being funded by my tax dollars.
Think of what this means to the real estate market, why would anyone want to loan on a piece of real estate when they are told even if a default takes place you will not be able to seek any recourse because the occupants have a right to stay there even if they do not pay. This will totally kill the real estate market for years to come until this nonsense is put to rest. With Acorn, getting this huge amount of tax money to push their agenda it will take years to settle out and there is no guarantee it will settle out in the bank or investors favor.
What should we do? The real estate market is being attacked on all fronts! Investors are bad, banks are bad, and loan holders are bad. The only people whom are not bad are the ones not able to pay their mortgage if they are part of the good mortgage holders as determined by the government.
If this is not communism, I do not know what is. If this does not depress any person interested in fairness, rule of law and the American way, nothing will.
If this part of contact law is breached, contracts in this country will be in jeopardy of becoming worthless over night. Think about this for a minute because I am talking all contracts, not just real estate contracts. This is the rule of unintended consequences and it is getting ready to run us all over in a way we have never seen before!
Chris B
For any that still think Obama is going to save us or even knows what he is talking about here is a good link to go and look at.
http://news.yahoo.com/s/ap/fact_check_obama
This demonstrates how in a speech lasting only about 45 minutes he made at least 8 statements that are just plain false or very questionable. This is the bright boy whom is going to save our economy? Pay close attention to the information about mortgages in this article.
Chris B
Yer, Wachovia’s investment of 24 bil and our bail out funds to cover the losses. Crap in…crap out…what did they think was going to happen? Such bad decision making. B.E. , you hit it on the head when you said “sound decision making must rule” . Unfortunately when $$$ is involved sound decision making and definitely ethical decision making falls by the wayside.
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