People shopping around trying to get the lowest monthly payment or the best nominal interest rate often overlook some of the subtleties in mortgage terms which end up costing them a lot of money in both the short and long run.
By understanding what to look for up-front, you can not only save a lot of money, but also keep yourself from getting scammed. Here are five common ways people get ripped-off or scammed when it comes to mortgages on their real estate.
1. Pre-Payment Penalties
If you pay too much of your mortgage too soon, the lender doesn't make as much profit --- after all, you only pay them interest on the portion you owe. If you owe less, you pay less.
Lenders often sneak in pre-payment penalties that help guarantee a certain level of profit. These penalties require you to pay an extra lump sum when you pay off all or a large part of your mortgage within a specified period of time.
Your best defense against getting ripped-off on a mortgage is to avoid signing up for pre-payment penalties. Why?
Because even if you make a mistake and get a rate that's too expensive, discover that you need to sell your house in short order, or run into other factors beyond your control, you won't have a boat anchor tied around your legs if you need to take action. Remember, some loans require the pre-payment penalty for any reason, including selling your house.
2. Negative Amortization
Let's say that you owe money on your credit card. You pay the minimum on your credit card every month, and while you know the interest is expensive, you also know that eventually --- if you don't buy anything more using that card --- you'll owe nothing.
Now let's say that you have a negative amortization mortgage. You make the minimum payment every month but now you owe more money than you did last month. You make the same minimum monthly payment the next month, and you owe even more money now.
What gives? Well, the monthly payment your lender lets you get away with is less than what your loan actually costs you every month. The extra money you owe every month is tacked on to the end of your loan.
It's like owing money on your credit card but racking up more and more charges on it. You'll never pay off the money you owe because you always owe more money. On top of that, most negative amortization loans, in the form of "option ARMs," include pre-payment penalties to keep you locked into the loan.
If you have one of these loans, you have the option to pay the minimum, the interest-only, or a full principal and interest payment. Treat paying the minimum like charging your monthly mortgage payment on a credit card.
3. Thinking About Interest Rate Instead of the APR
The interest rate you get charged on a mortgage is only one component in how much your mortgage actually costs. There is a list of fees that you pay in addition to the interest rate. Because these fees are different between lenders, comparison shopping just on the interest rate doesn't accurately reflect how expensive one loan is relative to another.
The annual percentage rate (APR) totals these costs with the interest rate so that you know how much you're going to pay, including lender fees. If there are no fees, the interest rate equals the APR.
(Speaking of no fees, when a lender advertises a "no fee" loan, it makes even more sense to compare APRs. The money that would be paid in fees often becomes a higher interest rate. After all, lenders want to make their money and being able to market "no fees" in their left hand is an easy way to distract people from a higher rate in the right hand.)
4. Equity Skimming Scams
Sometimes, when people are in financial trouble and their homes are at risk, a white knight approaches with an offer: they will "take responsibility" for your mortgage, paying it while you get back on your feet. All they ask is for a monthly rent payment and, as security on the mortgage, the deed to the home, which will be returned when the debt is paid off. The deed is transferred to the white knight using a quitclaim deed.
The kicker is that conveying the deed to the white knight doesn't relieve the former owner of the responsibility to pay back their mortgage. It just means that the security for the mortgage is now controlled by someone else.
A few things can happen at this point. The former owner can become a tenant of the property or vacate the property so that it can be rented out. If the tenant, whoever that is, doesn't pay the rent, the white knight can evict them and take possession of the property.
If the tenant pays, the white knight can collect the rent but not use it to pay back the mortgage. This money goes into his pockets and the house eventually goes into foreclosure, which the original owner is still on the hook for.
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A more advanced angle, described by the Department of Justice, talks about a property management company that approaches the same type of distressed people, folks facing foreclosure or tax liens. They offer to buy the property at a below-market rate in return for "debt forgiveness."
What happens instead is that the scammers get the property deed in exchange for what is a lot of money to people in financial distress. The victims are actually relieved because they can continue to live in their house (as renters) and now have a large sum of cash.
Unfortunately, the victims are still responsible for their original mortgage and the lump sum isn't enough to pay it off. The scammers have no responsibility for that mortgage but control the deed to the house, which they now have considerable equity in because purchased it below market value.
5. Straw Scams
You and your fiance find your dream house, but since you're just getting started on the rest life, you can't get a reasonably-priced mortgage. But your parents have pretty good credit and a strong income, so you ask them to buy the house for you and then transfer ownership to you using a trust deed. You promise to pay them on the mortgage that you couldn't qualify for yourselves.
That's a relatively innocent version of a straw scam. A more sophisticated version of the straw scam requires an unethical team comprised of an agent, a knowing straw buyer, loan officer, and appraiser to attack an unknowing seller. If you get offered well above asking price so that you can rebate it to the buyer, something's up.