How does your refi company make money?

My parents have been looking at new loans for them, and it's been a confusing time for them trying to see all the differences between the choices they have.

At first, they were going to go with the lowest interest rate, and then they realized that the loan would be for about 10k more than they currently owe. As I explained to them, that's because the mortgage broker was charging them almost 10k for the refi, but that rather than charging them upfront (and probably giving them cause to run away), he was spreading it out over the life of the loan. The monthly payment was lower than they'd be with the other company they were considering, but it came at a price.

My parents weren't too happy with the idea of increasing the principal. As it was, their previous lender had fooled them into an option ARM, and their principal had already increased over 11k before they'd fully realized what was happening.

So now they're looking at a mortgage banker who will charge only $450 for the refi but will use a higher interest rate. As I explained to my parents, the higher interest rate is how his company makes money, particularly since they say that they never sell their loans (very unusual). The second company additionally says it will lower the interest rate .25% if my parents open another account with them, such as a credit card or an IRA.

I told my parents that all companies have to turn a profit somehow, so the only way to choose is for them to ask themselves what is their most important goal. After all, as they're now in their 80s, they really need the lowest payment. They don't want to have to refi soon as this is likely the last time when they'll be able to handle it, so the payment needs to stay stable for a while but probably not for more than 10 years. They also need to talk to an estate planner to bring the whole picture together.

On the other hand, they have a real problem at their age with getting into more debt in order to help someone else make a living. And I can't say I blame them.

More refi horror stories

Some friends of our have gotten stuck in a refi nightmare. These are intelligent, educated parents with young children who started out a small starter home in a good neighborhood. They had a low tax rate and great schools. Then they got lured into a new tract with gorgeous houses, and they thought they got a great buy. They sold their first house quickly during the seller's market and put a nice down payment on the new house. They moved in, the builder made lots of repairs, and they painted and decorated. Things seemed great. The honeymoon period ended abruptly, however, when their insurance person decided to go over everything to make sure they had sufficient insurance. To their shock, he discovered that their impounds just didn't make sense. They double-checked and realized that the person who did their loan on the new house had used the tax rate on the raw land before the original property was subdivided and any of the houses built. Whoops...

Suddenly, they were faced with paying another 10k a year in property taxes as the new house also had Mello-Roos, bringing their tax rate to a whopping 1.8%. Values were high at the time, so they put the house on the market, but they weren't able to sell it. So they refi'ed only to find that their original loan was supposedly paid off while no new payment was arranged for them. This state of limbo dragged on for some days, then the manager tried to get them to take a different payment amount and also to sign off on the change. They realized then that the new loan agent had also made some kind of error, but that someone higher up had caught it because the company would have lost money on the loan. Eventually, they came to a compromise, but our friends still didn't have a loan they liked. The company promised them a free refi later on, but when they tried to contact the loan officer about it, he didn't return their calls.

So they went on to their 2nd refi, using their third lender. They decided to take advantage of the increased value of the house and take out some money to put into the property. They put in irrigation, sod, and a lovely stamped concrete patio with an Alumawood cover and fans. Then several months later, they looked at their statements, and realized that they owed about a thousand dollars more in principal each month. That's when they discovered that they'd been duped into an Option ARM, and that their payment, which had sounded so attractive, wasn't even covering the interest. In effect, they were doing a reverse mortgage! On top of it, they found out that just an interest-only payment would cost them about $4000 per month.

By now, they were sick of the house and were thinking of trying to sell it again. Prices were getting lower daily in the neighborhood, and now they saw that they were in debt for about 100k more than they could even sell it for, with luck, and perhaps after 7 months on the market. They considered refinancing yet again, but at this point, their newest loan officer recommended against it. He told them to stay put for a few years, continue with the interest-only payment, and wait until the market improves.

After my own parents' fiasco, I called them and told them that if they ever do get another loan, to please call me, and I'll come as soon as I'm able to read the whole trust deed before they sign it or at least before the rescission period runs out.

Oh, and by the way, one of the refi companies was ... you guessed it, Countrywide...

Don't forget to read your trust deed

I'd been telling my parents over the last few months some of the fraud I've seen and the terrible loans that people I know have unwittingly signed up for. Then my parents finally told me that some months ago, their monthly payment on their condo had suddenly gone up from about $875 to over $1400 a month, and they had no idea why. This was odd as they've owned a total of 4 homes over some 60 years and have refinanced numerous times. They're hardly beginners. On the other hand, they're elderly now, and they weren't familiar with some of the obscenely intricate loans that have come into existence in recent times.

They told me that they'd called their lender several times, and each time, they talked to someone different who told them to pay a different amount. I finally convinced them to go to Kinko's and scan the entire trust deed and have it emailed to me. These are some of the phrases I found on p. 19:

"The interest rate I will pay may change."
"The interest rate may change monthly..."
"My interest will never be greater than 9.950%."

On p. 20, I found the following statement:
"If the Minimum Payment is not sufficient to cover the amount of the interest due then negative amortization will occur."

Then on p. 21:
"Since my monthly payment amount changes less frequently than the interest rate, and since the monthly payment is subject to the payment limitations described in Section 3(D), my Minimum Payment could be less than or greater than the amount of the interest portion of the monthly payment that would be sufficient to repay the unpaid Principal..."
"For each month that my monthly payment is less than the interest portion, the Note Holder will subtract the amount of my monthly payment from the amount of the interest portion and will add the difference to my unpaid Principal, and interest will accrue on the amount of this difference..."

Then I found the following:
"My unpaid Principal can never exceed the Maximum Limit equal to ONE HUNDRED FIFTEEN percent (115%) of the Principal amount I originally borrowed. My unpaid Principal could exceed that Maximum Limit due to Minimum Payments and interest rate increases. In that event, on the date that my paying my monthly payment would cause me to exceed that limit, I will instead pay a new monthly payment. This means that my monthly payment may change more frequently than annually and such payment changes will not be limited by the 7.5% Payment Cap. The New Minimum Payment will be in an amount that would be sufficient to repay my then unpaid Principal in full on Maturity Date in substantially equal payments at the current interest rate."

I called my parents and told them that they needed to refi ASAP. They had been told about negative amortization or reverse mortgage as an option, and they had chosen not to do it because they believe that it's unethical. Yet that's exactly what they had gotten themselves into. As the interest rate can only go up (and it's now at about 8% for them!), they fail to pay principal and even fail to pay all the interest. They end up owing more, and the debt simply escalates.

In addition, when I first got into real estate, a lender told me that "pick your payment" was a good loan for agents, such as myself, because the borrower can pay more or less each month according to his or her varying income. Now, since when did people in their 80's have a lot of variation in their income? Guess what, my parents' loan also has a "pick your payment" paragraph as it states toward the bottom of p. 21:
"After the first Interest Rate Change Date, Lender may provide me with up to three (3) additional payment options that are *greater* than the Minimum Payment, which are called "Payment Options."
Ooh, boy, that explains why every time they called, they were given a different amount to pay. I told them to get the amounts in writing with an explanation of what each amount represented. They had no idea if a new amount covered any principal at all anymore.

Basically, a loan officer who didn't care that my father is retired and 81 had played bait and switch with him. He lured my parents with an incredibly low introductory interest rate without explaining to them that it was very short-lived and would change dramatically, probably putting them further into debt unless they refinanced quickly. The loan officer didn't plan on being around when my parents found out what had been done to them or perhaps he just figured that they were too elderly to notice or even do anything about it.

This should be criminal. At the very least, it's predatory lending. But my parents probably don't have enough time left to them on this earth to pursue a lengthy lawsuit. At any rate, they signed off on everything. But that's what they do, isn't it? "Sign here, here, and here." People don't get enough time to read it, and they get intimidated, wondering if someone thinks they're idiots for not understanding more quickly. So they sign, and then they're in debt forever.

I have asked my parents not to sign anything again until I've had a chance to read through it first. The borrower is supposed to get enough time to read through the papers and also have some time to change his or her mind after signing. Don't let your parents give up these rights.

Oh, and by the way, the lender was Countrywide...