Negative Amortization: Never the Best Option, but Sometimes the Least Bad

Looking for advise on Neg. Am. loans.

I live in DELETED and I recently went into an office with a buddy asking about a refi and cash out loan on my existing homes in order to help with cash flow. I briefly talked to the broker who was trying to close two loans for my buddy. He said yeah I could probably get you a similar loan 1% or so and cut your payments in half. You'll need to refi in 3 years or so.

I Left my old job ( Sales ) and I am in my first development project subdividing 2 lots in to 4 with custom homes on each. Time line has dragged on dramatically ( approaching 2 years ) and budgeted money is running thin. Should start building within next few months and complete with in 15-18 months. Should make good profit.

In addition I own two SFR's and I have 549K loan on primary and 297K on non owner. Each appraises over 800K.

To help with purchase of the other properties and need of cash flow I also exercised LOC's of 150K and 90K on these properties so total mortgage debt is :

* $ 1,087,550 payments of $6152
* new loans proposed are 650K primary and 595K non owner for total of :
* $ 1,245,000 payments of $3442 saving $2710 per month.
* terms 40 yr : 1.25% on 650K
* terms 40 yr : 1.75% on 595K

* Question are :

1. What should the fees be on these type of loans ?
2. It looks like little over 27K, is that high, seems like it ? Isn't the broker getting kicked a high commission on the back ?
3. Should there be prepayment penalties ? I'm/ /being told can only sell after the first year and cannot refi for 3 years.
4. What index should this be based on ? Think he said one that is constantly moving ?
5. Approximately how much is being added to the principle each year ?
6. Should I be allowed to make extra principle payments each month or at my discretion without incurring penalty ?
7. *** Should I do these loans ? What are the main things I should ask for and stand firm on ?
8. Am I being duped ?

Thanks for any advise. The broker has avoided specifics for the month and now sent an email saying docs should be ready tomorrow and location of Escrow office. When I asked what the specifics were, penalties, stipulations and what would be added to each principle per year ? and if he could get me something in writing he said " When you came into my office, we sat down and went over each program. If you'd like, you can call me and I'll be glad to explain exactly what your loans are going to be. There aren't different scenario's. You told me what you wanted and I got it for you at the price/payment you wanted. "

Coincidently, my buddy was called day before his docs were ready, they were sent to his house the next day with a Notary to sign on spot. While looking over he noticed things they discussed had changed and called him on it, he said take it or leave it, and he opted to leave it.

Seems odd to hear nothing and be avoided on questions other than its what we discussed in the office which was very brief and non specific. Now he's ready for me to sign. Really concerned about fees, penalties and addition to principle.

Answers to your questions:

1. Closing costs on NegAm loans are about the same as any other loan. $3500 as a rule of thumb, perhaps a little more because your loans are bigger (so title and escrow cost more, appraisal is a little more). Even if you're adding impound accounts and paying 30 days of interest, I can't see closing costs of $27k.

2. Yes, $27 k is too high. But every dollar they can skim is a dollar in their pocket, and since what you are looking for is a low payment, it doesn't make much difference to the payments, so they figure you'll sign. As I've said before, these loans are a way for them to appear to compete on price without really competing on price.

3. I do not know of any negative amortization loan where the pre-payment penalty can be bought off completely. It's built in to every single one I've ever found. I occasionally use that as a come-back while I'm throwing the idiots who wholesale these out of my office; "You say you've got something worth my time, and then you tell me about these POS loans that everybody else is pushing for all they are worth. Were you lying, or do you have one without a pre-payment penalty?" To date, nobody has said yes. The prepayment penalty he quotes, is one of the less bad ones, but I'll bet, sight unseen, that he boosted your margin above index rate to buy it down. The best one I've got, the penalty is "soft", waived if you actually sell the property.

4. Negative Amortization loans are pretty much all based upon COFI, COSI, or MTA. All of them are moving rates that change slightly every month. I do know of one where the underlying rate is fixed for three years, but the minimum payments are higher, and it wasn't exactly a great rate when I was told about it some time ago (6.9% plus adds that depend upon the situation)

5. That depends upon the underlying rate, which is your index plus a set margin. Most of them are sitting in the range of 7.75 to 8.25%. (I initially assumed 8%, but it was 8.4) 8.4% times your total balance is about $104,500 of interest per year. Less your payments of about $41,300 adds roughly $63,200 per year to your balances, not including compounding or shifts in the index. Incidentally, you are not saving money on the real cost. You're simply deferring part of the cost until later and allowing it to compound. Comparable "A paper" rates on 30 year fixed might be about 6.25 and 6.5% respectively, or about $80,000 per year of interest, which would save you about $2000 per month in the real cost of the money, interest.

6. The reason they're called Option ARMS or Pick a Pay by some people is that you get a choice of four payment options every month. Nominal, interest only, 30 year amortization, and 15 year amortization. Depending upon the lender and the product, the prepayment penalty can be either "first dollar" (i.e. pay anything other than one of the four payment options and gotcha!) or 20% (you're allowed to pay down 20% of the principal each year without triggering the penalty).

7. I advise very strongly against these on your primary residence, and on investment property there are usually better alternatives. However, you're kind of in mid-leap, and from what you say, it seems like you have a cash flow problem. You're committed, and there may not be a better alternative to doing a negative amortization loan. If your project doesn't work out, you've got serious issues, and you can't not start at this point.

8. It does appear likely from where I sit that there are much better bargains out there. I avoid these loans like the plague on humanity that they are, but if you've got a valid reason why they are the least bad alternative for you (and it seems like you might, with your impacted cash flow situation), chances are excellent that I can do something better. I don't know enough about your situation to make any type of guarantees, but if you're not in an emergency situation where you need the money within the next three weeks, I suggest you shop your loans around. This place is making about 3.75% on your loans, or $46,500 for the two loans, plus junk fees. These loans aren't that tough. Whereas the important thing to you is not how much they are making but the bottom line to you, I suspect that you can find other folks willing to do both loans for considerably less, by giving you a rate that doesn't add nearly so much to the underlying index (Wall Street, and therefore the lenders pay based upon the margin, which is quite simply the addition to the underlying index that you agree to pay in your contract). Furthermore, good loan officers live on specific numbers. I'm delighted to discuss exactly the loan I'm going to deliver to my clients once I have shopped it around and know what that loans terms are. Every loan I lock has a Guarantee attached to it: These are your terms, or I pay the difference. The upshot is, I strongly suspect you can find someone who will deliver a better loan cheaper, whether you stay with a Negative Amortization loan like I suspect you will, or go with something with a better rate fixed for a longer period.

Caveat Emptor