I have a relative with an interest only loan. She's been making the minimum payment for almost two years now and her principal is showing as -4,000 on her mortage statement. I'm supposing this means that in addition to the outstanding balance, she owes another 4,000. Is that correct? Such as if her loan balance was 250k, if she sold her house, she'd owe the bank 254k?
Also just read up on "discount" points in my real estate class, what a crock of crap! I hope one day that they become illegal.

First off. Take what you learn from your instructor with a grain of salt at least the opinion part.

If your relative is in an interest only loan it is not a neg am loan and there would be no deferrred interest that they would owe. Interest only is just that you pay at minimum the interest due on the loan. Before you "counsel" your relative with your limited information and slanted opinions break out the closing package from their closing and read the "NOTE". It will spell out in no uncertain terms pardon the pun the TERMS of the loan.

As for discount points being illegal, what a naive' statement. When used properly they can be advantageous to the client. Rarely does it benefit someone to pay discount points but at times when they intend to stay in the home and the mortgage it makes sense. Perhaps you are confusing origination points with discount points.

Hope that wasn't too harsh but if you are going to be counseling clients be sure you know what you are talking about. My suggestion is to find a reputable mortgage broker in your area, go to lunch and pepper them with questions to gain knowledge. Please don't wing it with your clients

Whoa. THanks for the reply, but I'm not licensed yet, and I'm not counseling anyone. I'm not the type that wings anything, that's why I've started visiting this board for the sole purpose of boning up on knowledge. In this case, I'm just concerned for my relative and seeking expert advice of the board-members. In fact, she's making a payment that is below the "interest only". She has 3 payment options, one is a "minimum payment" one is "minimum payment + accrued interest" and one is "fully amortized payment".
I see two line items on her mortgage statement that concern me. One is for Unpaid Deferred Interest Balance which is several thousand dollars and the other is Principal Paid YTD which is negative a few thousand. So my question is: If she sells her house, will she owe the bank actually more than the principal balance?

I will take your advice and look at the note and terms in the closing statement for more info.

RE: the discount points. The definition I read in my textbook was that a "discount" point was used in the event that a lender wouldnt get the full return they wanted just with the interest of the loan. ie. a VA loan which is a lower interest rate than average, a lender will use "discount" points to even out this lower return. What I think is b.s. about the whole situation is that a. it's called a "discount" point. In no way do I consider an extra fee a "discount" even if the overall interest rate is lower/discounted. b. I don't like that it reduces the actual amount of money you receive at closing, yet you are still responsible for the interest on the full amount.

You are probably correct that I am naive because I lack experience of seeing how discount points can actually play out, but just on face value, I don't
like the idea and it seems like an unfair tactic.

If I'm not mistaken origination fee is the one that's basically a charge for them doing the paperwork, right?

Your relative is in a pay option arm,if she is only paying the minimum payment then she is loosing equity every month. So based on what you said earlier then yes, if she sells the home she will owe the bank more than her original loan amount. She will have to pay back the principle plus the unpaid interest.
These loans do have some good usess but unfortunately several people are in these loans and don't understand how they work.

Thanks Mickey,

Yes, I've talked with my dad about a few ways that these loans are useful. Such as for rental properties, where you can give yourself the option of a lower note to free up capital, and still be generating good income. Also if you plan on not staying in the home long because the first few years give very little to principle anyway.

I told her going in that she was being taken advantage of, because the builder's lender was really hounding her when she was looking at the house. They wanted to make her think she could afford this house with this loan, not fully explaining the consequences. I didn't fully understand them at the time, either, and I wasnt putting much into researching it because her mind was set. All in all, I think people should be more responsible with such a huge decision in really learning their rights, but not everyone is, they just want what they want and think little of what they need.
God willing she can sell this house for more than it's purchase price....

Here's how discount points work.

If you borrow $120K @ 7% your payment is about $800
If you buy a point and get a rate of 6.5% your payment is about $750.

After 10 years you've saved $6000. Since the point cost $1200 you would have been smart to buy one.

In this example you'd need to stay in the home for 25 months for there to be any benefit to buying a point.

Nice example Aaron. Thanks.

HI Anjel,

Once you mentioned a "builder," I tought "uh oh. Hyper aggressive LO." I've worked builder sites and condo-conversion sites as a real estate agent. Lots of money t be made, but the idea is GET THE PLACE SOLD. and yes, many LO's who work in those offices are hungry and aggressive. They do absolutely push programs like the option-arm and are often lax in explaining all the nuances of the program.

If your relative was making the lowest payments by choice, then she can start paying the 30 year payment to recoup a little equity or at least the actual interest only payment to stop the bleeding. but if she is making the lowest payment because that's all she can afford, then there are two other things she needs to be very concerned about.

1. The loan will only allow negative amortization up to 110% or 115% percent depending on the program. Which means that let's say her loan is for $150,000. The once the neg am causes the principal balance to hit $165,000 or $172,500, the loan will automatically adjust and require the fully amortized fixed rate payment to be made from that month forward. You need to check the Adjustment Rider which will be after the loan info in the mortgage package. It should explain it. Also, your relative should call whoever is servicing the loan now (since I can practically guarantee the loan's been sold) and ask them what her cap is and how close she is to it.

2. If your relative's been in the loan for almost 2 years, then you need to see when the option ends. Option Arm's are usually locked at the start rate for a period of time. This can be 2,3,5,7, or even 10 years. Make sure hers is not 2 or 3. because if it is, then her payments will go up once the locked period ends, which will be soon. And I mean UP! Of course most Option Arms also come with prepayment penalties, so make sure she's beyond hers before you try to refi or sell or she'll have to pony up some dough.

To be honest, you should talk to your relative about refinancing (unless she wants to sell the place now) into a regular IO ARM or a fixed rate loan. The Option-ARM is actually a very useful loan, but it's more like an off-roading vehicle than a ferrari. You take it out if you like to go rough and tumble. It's a loan for dice-rollers. Your relative sounds like she wants more of a cadillac loan. A smooth comfortable ride. If her credit is good and she can prove her income, she should be able to smooth things out with a regular fixed-rate loan. And if the property is in or around Atlanta, then chances are the property has appreciated pretty well in the last two years, so a refi for a higher loan amount than she started with might still work out.

Good luck,

Dan

The Option ARMs or Option payment loans are the most misunderstood products in the marketplace.

While they are definately not for everyone, they can be looked at in many ways. I often tell people this. Just about every homeowner borrowers against their equity at one point or another either through a cash out refi, equity line, second, or whatever. Is that not negative amortization and in a big way? In a POA you have the option of accessing your equity in very small pieces in the form of a minimum payment option. Again just one way of looking at it but real thing is the program works best for the financially disciplined and very few homeowners are that. The hotest new product now on the market is a POA with 5 yrs. of fixed payments and fixed rate, a little less risky than the typical libor or MTA indexed product.

By the way, they are called discount points because you pay them to discount down the rate. IMHO we don't need any more govt. regulation in lending or RE, there is consumer protection up the ying-yang already, especially in some states. Maybe it's time that people take responsibility themselves for their actions, start reading and understanding things before they sign and stop looking for the govt. to protect them against everything.

As another mentioned, not good to rush to judgement based on what one real estate instructor says.

Thanks a lot DCook, that was good advice. Sad thing is, she's not only in this POA, it's a 40 year! I've got to get with her and look over her closing papers to see what she's got going on. I dont think a re-fi is an option for her, and I've really been encouraging her to sell. There's about 4 others selling in her sub-d, none have gone yet. But, she's got the only one with a basement and some nice improvements so she's got the advantage. Also thanks for the info about prepay penalties, I wouldnt have thought to look at that.

Hyper Aggressive LO is an understatement. The lady was practically a stalker. Talk about predatory lending! haha.

SD, Again, it's what I READ. Not what the instructor told me. I take an online class, so my communication with my instructor is limited. He's available, but his answers are real textbook. Which is why I like the varied and subjective opinions on this board.

I'm not much for government interference, but I think what a lot of banks do is downright dirty. $30 overdraft fees on a $2 overdraft is just plain ridiculous. Sure, people should read, but in reality, not everyone can understand 10pg legal documents, and not everyone can afford a lawyer. People often depend on/trust the person on the other end of the table to explain to them what they're signing to. Example: My fiance works for a major tax prep company and he sold me an IRA. When I bought it, I told him I didnt like the interest rate but asked him if I could transfer it into another brokerage later. He was like sure. He didnt mention that I'd have to pay a $100 fee. He wasnt trained very well on the product, and I think the company purposefully doesnt train their employees well on new products (though he wont admit it). When I transferred the IRA to my reg brokerage, I saw my acct $100 less and then found out about the fee. I called him pissed as hell and he told me I should've read my book. And he was 100% right. But there was the trust thing...I would've expected the person selling me the product to tell me about the fee when I asked about the transferring. But, actually, he didnt even know. I think we're both at fault, but ultimately my responsibility. But again, banks, etc. get dirty. Another weird thing the first year they were selling the IRAs--was no one, in his whole office knew the name of the actual bank holding the IRA. They were all trained to tell customers to call the regular 800 # of the tax preparer and ask them. When I called there, I had to go thru like 3-4 more numbers to actually find the bank. This year, they have all the right phone numbers posted etc. But I heard there's a guy that's been suing the hell out of them for this exact type of thing, so maybe they were forced to.

Sorry so long

Yeah sounds like your relative should be either selling or refinancing her loan. POA's have their place and Im sure your relative appreciated the extra free monthly cashflow, but if this LO sold this loan to her based only on trying to get her into a more expensive house he should be shot.
Luckily if she bought it 2 years ago she's got plenty of equity in it and she can probably refinance to a lower rate.

Banks certainly aren't angels, their out to make a buck just like everyone else. But calling a discount fee a "crock of Cr@p" is a bit overkill. You certainly don't have to pay a discount if you don't want but expect a higher rate.
The banks are in it to make a profit, Either it's going to be at the front of the loan through a discount point, or by charging a higher interest rate and selling it on the secondary market for their profit.