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.