Beware of Mortgage Refinancing Traps.

By: Christine Carter

The mortgage lending business is highly competitive. And that, my dear reader, is an understatement. It is like saying that the Pacific Ocean has many gallons of water in it. Even Donald Trump this week decided to enter the mortgage arena with the hyped up launch of Trump Mortgage from Las Vegas.

With literally thousands of companies all competing for a finite number of borrowers, the temptation exists to use tricks, gimmicks, and even outright deceit to obtain more home purchase or mortgage refinancing customers. Most people like to assume that their doctor, dentist, pastor and banker are all fine upstanding citizens above reproach and would never resort to deceit for personal gain.

While that might be true for your doctor, dentist, and pastor, it likely might not be true for your banker, especially if your banker is advertising online with below market "introductory" rates. As with most things in life, if it seems too good to be true, it probably is. Banks, like most other businesses, exist to make a profit. If they are offering below market rates, you can bet your hard earned dollars that they will be getting their profit in some other manner.

It is those other hidden ways in which lenders try to profit that you need to guard against. These other ways are usually buried in the fine print of the paperwork, and more often than not are more expensive than simply opting for the current prevailing interest rate.

Trap 1: Prepayment Penalty

For many years prepayment penalties all but disappeared from the mortgage lending scene.

Unfortunately, they are making a comeback. Usually prepayment penalties are inserted into the loan documents by the lender to get additional profit. This is especially true if you have a below market interest rate. What the lender would have received in interest payments is instead received as a prepayment penalty when you pay the loan off early (and early can be any time before your last payment is due 30 years from now).

Trap 2: Negative Amortization

Have you seen a mortgage refinancing advertisement offering incredibly low payments? Do you wonder how any lender can offer payments of under $500 per month on a loan in excess of $200,000? The answer is negative amortization. This occurs when the monthly payment isn't sufficient to pay the entire interest payment each month. The unpaid interest gets added to outstanding loan balance each month, and the result is that the outstanding balance on your loan increases each month, rather than the standard decline.

If you initially borrow $200,000, but your low monthly payment doesn't cover the entire interest due each month, several years later when you sell your house or refinance it, you end up paying the lender a great deal more than $200,000. Also, these loans most often carry a higher rate of interest than the current prevailing rate. This happens all too often because borrowers tend to focus primarily on monthly payments and overlook most other details of the mortgage loan. Borrower beware.

Trap 3: Initial Low Interest Rate, Subsequent Above-Market Rate Thereafter

Credit card companies are notorious for this offer, and their mortgage lending cousins have in recent years begun to use the same trick. Let's say that your mortgage rate is tied to an interest rate index such as the 10 year treasury note. The prevailing national rate for a 30 year mortgage might be 2% above this index.

To attract borrowers, the lender might advertise an interest rate that is equal to or less than the current rate on the 10 year treasury note. When you examine the fine print, you'll discover that this low introductory rate only is valid for the first 6 or 12 months of the loan, at which point the interest rate would immediately change to the rate on the 10 year treasury note plus 3%. Lenders using this type of loan arrangement typically will also insert a prepayment clause into the paperwork. The result? You are trapped with a home mortgage that carries an above-market interest rate, and you have to pay to remove yourself from it.

In nearly all cases that I've examined, overall it is less costly for the borrower to shy away from the enticing offers and simply choose the best interest rate offer available at the current prevailing rates. Shop for the best straightforward deal you can find. Longer termArticle Search, you'll be glad you did.

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