A former client recently reached out to me for help. It seems he had lost my number and had gotten caught up in a refinance sales pitch from another company. “What could be so bad?” he thought. No out of pocket closing costs and a payment that, on the surface, seemed like it would save him money. But, within a year his principal balance had zoomed from $600,000 to $675,000!

Turns out he had signed on for a negative amortization loan. Not just any neg am loan, but one with a margin of 3.75%! So each month that margin was added to an index to calculate the interest rate. In his case, the index was the CODI (Certificate of Deposit Index). And by the time he came to me, the index was at 5.3%. Add the margin of 3.75% and his interest rate was over 9%!  This at a time when interest rates were FAR LOWER.

His monthly payment was $1929…but the amount he owed that month was $4,713! The difference of $2784 was added to the balance of his loan. If the margin stayed the same (unlikely), his balance went up over $38,000+ the first year. Now, add in the cost of the refinance…and he was in deep neg territory!

That’s the difference between a mortgage salesman and consultant.

A salesman is out to profit at your expense. The higher the margin, the more the lender pays.  So, a salesman will hike up the margin to line his pockets. The salesmen who suckered my client charged a 1% origination fee, a $595 processing fee, a $350 administration fee, and pocketed a 3% premium from the lender. He made out like a bandit while my client took a bath. In addition, my client had a 5% prepayment penalty for the first 3 years. Had he gone to a mortgage consultant instead, he would have had a margin of 2% or less…attached to a lower index…with a zero broker’s fee. In short, a loan he could live with.

So when a customer asks me for a neg am loan, I only give it to him if I feel the circumstances are right.  He has to be a savvy borrower. The upside of the transaction needs to be good. And, it has to be refinanced after a year or two. I also make sure it has the best possible terms: A low margin. No prepayment penalty. And, bi-weekly payments.  (The 25th and 26th payments help eat up a portion of the interest accrued.)

I’ve occasionally seen investors who do well with a neg am loan as long as they get out of the market at the right time.  But with loans as with life, timing is everything!