A loan that'll get ugly fast

[n2doc]

A loan that'll get ugly fast
By David Streitfeld, Times Staff Writer
December 11, 2006



EVERY day, Will Hertzberg owns a little less of his three-bedroom house in Corona.

Like hundreds of thousands of other homeowners around the state, Hertzberg has a mortgage that lets him choose how much he pays each month. Like many of them, he always chooses to pay as little as possible. For the moment, this allows the 56-year-old Hertzberg to continue living in his tract home despite being only marginally employed. But his debt is swelling, and his mortgage company controls his fate. "I am rather screwed," he said.

Alarmed regulators recently have attempted to force lenders to cut back on loans like Hertzberg's. Even some industry executives are beginning to wonder how these borrowers will handle their added debt, especially if housing prices stay flat or fall. If it turns out that many can't, it would be a major blow to the housing market. In the worst outcome, it could drag down the overall economy. Hertzberg could sell now, but his lender would charge him an $11,034 prepayment penalty — money he doesn't have. Yet if he stays, the housing market may tank, vaporizing what little equity he has left. "I made choices, and they happened to be the wrong choices," said Hertzberg, a big guy who lives alone amid the clutter of decades of memorabilia.

The real estate boom of the last few years has made it very easy to become overextended. Earlier generations bought houses knowing they had no choice but to keep paying at the same rate for three decades. Their reward: the ability to sleep well, knowing their payments wouldn't abruptly adjust upward. As interest rates rose in the early 1980s, many borrowers couldn't afford these traditional loans. Lenders responded with adjustable mortgages that offered lower introductory rates. A few years ago, as home prices began escalating sharply, lenders pushed loans that let the homeowner pay only the interest for an initial period. When even that was too onerous for some borrowers, they offered loans such as Hertzberg's, often called "pay option" loans.

One of his options is to pay $2,513 a month. That would cover the principal and interest as if it were a traditional 30-year loan. A second possibility is to pay $2,279, which would cover only the interest. But each month he always takes the cheapest option: paying $1,106 and promising to make up the shortfall later.Essentially, option loans are bets that good things will happen. Maybe the mortgage holder will get a big raise, or sell a script to Hollywood, or inherit a chunk of change. When the borrower has to start paying off the loan in earnest in five years, the plan is that he or she will somehow be able to handle it. At a minimum, the borrower is betting the housing market will be better in a few years than it is today. If the house goes up in value, it will be possible to refinance and the day of reckoning can be put off once again. In 2003, only about 8 of every 1,000 people buying a home or refinancing a mortgage in California got a pay option loan, according to San Francisco-based data tracking company First American LoanPerformance.

Last year, 1 in 5 loan applicants got one.

More:
http://www.latimes.com/news/la-fi-option11dec11,0,5533780,full.story

[BOSSHOG]

1. "Pay Option" Loan

Incredibly bad idea. You'd think they would come up with a better name. Who would agree to sign a contract which gave you the "option" to pay without thinking real hard? Yeah, all mortgage companies will just let ya pay. If you don't want to okay!!! Very sad indeed.

[DainBramaged]

2. If these scumbags call in the paper, the economy tanks.

I cannot believe how shortsighted these predators are. Do they think selling auction properties at a loss is worth it?

[NashVegas]

3. Why Should I Feel Any Sympathy for This Man?

Comparable homes in his neighborhood fetch more than $400,000. With fresh paint and a few repairs, Hertzberg could probably sell his place for $275,000 more than he paid.

He would see little of that, however, because he's already seen so much. Over the years he has taken out $190,000 in cash through refinancings.

Hertzberg's home equity paid off his credit cards, financed trips around the world that allowed him to indulge his passion for photography, bought a $32,000 Toyota Avalon and enabled some lousy investments. He bought dot-com stocks and lost money. To recoup those losses, he bought commodities — and lost money faster.

"Free money always has the unfortunate effect of making people go overboard," said Hertzberg, whose living room is strewn with financial publications including American Cash Flow Journal and Donald Trump's "How to Get Rich." "You'd be surprised how fast $190,000 can go."

The trend of he and others like him - speculators and others all too happy to take credit and live beyond their means - has helped drive up housing costs to the point where those of us with moderate means have to work two jobs to afford a mortgage on anything bigger than a shoe box.

[jelly]

5. I have mixed feelings

I mean, people are only human and some find it hard to resist the the temptation of these short-term benefit, long-term risk type loans. The more in financial dire straits you are, the harder is the effort to resist. And it's not just people who have made "mistakes" or who have spent indiscriminately who find themselves in trouble. What about people who get sick, or people who suffer or whose family members suffer serious accidents and need time off to recoup. Rather than the subversive temptation of predatory lenders there should be more government intervention to help these people survive the tough times.

But regardless whether we have sympathy there should be laws to stop these practices because they hurt everyone, including as you note those with the discipline to avoid taking out such loans. That's why it makes me want to puke when Bush brags abotu how under his administration, home owning is at an all-time high. Assuming that's true, the increase is largely attributable to people who have signed their lives away to his rich banking campaign contributors. I share your frustration about the market. Three years into working a decent full-time job out of college and I still live in an apartment because I cannot afford a home. To afford one in the area in which I live I would either have to buy a dilapidated fixer-upper (and I am not a fixer upper type o' gal) or buy the house I want while giving up just about every other little luxury in my life such as going to the movies and buying a new outfit once in a while. I simply cannot bring myself to give up all that. I blame out of control lending practices for the increasing disconnect between the price of housing and wages. I resent having been presented with the choice between entering into indentured servitude with a mortgage lending institution and not owning a house.

[CrispyQ]

9. I don't feel sorry for him either.

Members of my family are living large off their equity. New furniture, new cars, exotic vacations, toys & trinkets galore! They scoff at our little house, our old furniture, our older cars. However, when talk turns to work, they speak enviously about how we live on my 25 hour a week job.

Madison Avenue has done a masterful job deceiving people that life is about trinkets.

"Time is the essence of our lives."

[hedgehog]

4. If last year 1 in 5 applicants took out a loan like this, they aren't all

speculators like the guy in the article. Once again a major story is buried by holding up as "typical" someone who would probably be in trouble no matter the economic situation. I suspect the majority of people holding these loans took them out in desperation because it was the only way they could buy even a modest house in an over-priced bubble market. I don't think people in California make higher wages than they do around here, but I see houses going for triple the price that they do around here. Something has to give.

[jelly]

7. Collective action. But since collective action is impracticable

we need laws. I think we would see an almost immediate decrease in housing prices to more realistic levels. Of course, maybe that's easy for me to say because I have yet to buy a home. People who have bought homes in the last 5 years or so would find themselves stuck with a mortgage in an amount much greater than the market value of their homes. Not sure what the solution is but as you say something has to give because the current state of affairs is untenable.

[lectrobyte]

13. The guy in the article didn't sound like a speculator, they do mention

he's been living there for 11 years. He has taken out the equity and spent it, though, that seems like that's the biggest mistake he's made. Otherwise, he could probably sell the house, and take the profits and make a new start in a lower-cost-of-living place.

[ThomWV]

6. There Are Subtle Inaccuracies In This Piece

There are a number of subtle inaccuracies in this piece that hint at the age of the writer but do something more important than that as well. They show how impressions of everyday financial life in this country have changed.

Let me point out two of them as examples.

In the second paragraph: "Earlier generations bought houses knowing they had no choice but to keep paying at the same rate for three decades." The earlier generations are the ones living before the 1980's in this case (see the entire paragraph to see the time relationship). The thing is that nobody financed a house for 30 years back them. Conventional mortgages were generally written for 20 year terms, not 30. It was also unheard of the finance a car for more than 36 months back them, and 24 month car loans were common.

Another thing you said was "As interest rates rose in the early 1980s, many borrowers couldn't afford these traditional loans. Lenders responded with adjustable mortgages ..." Well, that's not exactly true either. When interest rates rose (up to the astronomical heights of 18% or so) banks didn't come out with adjustable rate loans, what happened is the economy came to dam near a standstill as mortgage applications simply stopped. Adjustable rate loans didn't come into existence until long after the really high interest rates dropped. Once again the old law of supply and demand kicked in.

[hedgehog]

8. We've spent twenty years paying off a mortgage on a very modestly priced

house because our first mortgage ran at 12.5%. We've re-finnaced several times, and will finally finish up in seven years. If we could have had our current interest rate to start, we'd have paid off the mortgage 15 years ago and would have been able to save for college. Instead, I'm taking out college loans now!

[n2doc]

14. I had an adjustable loan in 1983

However, the amount that it adjusted by and the initial rate weren't as screwy as they are now. I remember it started out at around 9 and went to 12 percent before declining slowly. The loans were out there. Another big difference was that the banks at least paid some attention to the borrower's ability to pay.

[jelly]

15. That's why it was important to leave bankruptcy laws alone

You're right banks seem to care less and less about the borrower's ability to pay. I think if banks are stupid enough to lend money to people with less-than-stellar credit ratings and an uncertain income-producing future, banks deserve to get stuck holding the bag when those people find themselves unable to pay and declare bankruptcy. Tougher bankruptcy laws mean that the debt is now more likely to follow desperate consumers around til their dying breath. A few financial missteps in your 20s and you could spend the rest of your life giving away a large percentage of your income to the Man. It's modern-day indentured servitude.

[EnviroBat]

18. Right, and let's not forget that it can and does happen to people with great credit scores too.

You could get outsourced tomorrow, and lose everything. That stellar credit score goes down the toilet real quick when there's no more money coming in, and you have to prioritize food vs. credit card payment.

[jelly]

19. Yep, which is why credit card debt in general

is a horrible idea. America needs to break its addiction to that scumbag industry. If we can't stop it altogether at least if banks are forced to give serious thought to a person's ability to pay that would stop some of the preying on the most vulnerable members of our society.

[CoffeeCat]

10. This is wrong on SO many levels...

The article says that "alarmed regulators recently have attempted to force lenders
to cut back on loans like Hertbergs..."

Excuse me, but why is a loan like this even allowed?

I don't buy that the "regulators" are "alarmed". Loans like this have been passed out like candy,
for several years now. This kind of financing is common, and regulators are now coming out, and
they're shocked? Oh please.

Also, why are people using their houses like ATM machines? What is wrong with people? People used
to save up for vacations, furniture and cars. Now, we're like 3-year old who want it NOW...and we
run to our equity (or use credit cards) to finance junk or expensive items that we cannot afford.

People are owned by the man---because they've financed EVERYTHING. There is so much debt in this
country. It's sick.

What's even worse is that there are no "regulators" anymore. The banking industry allows these
irresponsible loans and credit card companies are more-than-anxious to give someone who makes $25,000
a $10,000 line of credit. Eighty percent of Sears' profits come from financing purchases. We've
turned retail stores into finance companies. You can finance a car for 10 years now.

Why did the government allow Americans to totally screw themselves financially? Possibly, George Carlin
has the answer--when he talks about the government wanting us weak and broken--so they can control us.

All the way around--this is just rotten and perverse.

[NashVegas]

11. See the Documentary "Secret Life of the Credit Card"

Or "Secret History," I forget which.

They interviewed the guy who first came up with the idea, in 1979, that credit card companies could make more money by reducing the minimum payment to 2% of charges, instead of the standard 5%. This encouraged people to a) draw out their payments, leaving the companies to make more money on finance charges, and b) spend more.

The funny thing about it is, this man agreed to be interviewed, but only if the film wouldn't give out his location.

Because of this, I'm not so certain the latest legislation giveaway was 100% in favor of credit card companies. In the long run, I think/hope it will discourage some people from getting in over their head in a way some people did when credit cards were more "fun."

[Wcross]

12. People that live above their means will pay for it one day.

I took the exact opposite approach to housing, I bought a home that was a little bit less than what a make in a year. I paid 60% down using money I saved while living in a cheap rental unit. I took out a 5 year fully amortizing loan and will have it paid off next year. It is a very small home (680sqft) but it sits on 15 acres.
Why didn't I do it the traditional way "Buy the most expensive home you can afford"? I didn't because I am really concerned about my financial/personal security. I never want to be forced out of my home. I am also very comfortable with who I am and have no need to impress other people with a house I can't afford. In my eyes, signing up for a 30 year loan at 36% of your yearly income is akin to signing up for financial slavery.

[jelly]

17. 5 years ago?

Assuming you live in a market that has followed the average nationwide housing trend, you might not think your house was quite as hot a deal if you tried buying it today. People who bought in 2000-2001 are for the most part okay.

In general though I am with you about being averse to financial slavery. I am just pissed that the choice is between financial slavery and owning a nice home. A few years ago with my income I could have owned a fairly nice home and the decision to buy it would have been a financially responsible one.

[EnviroBat]

16. $2,513 a month!

What middle class person could afford that by themselves? It's fucking rediculous, and I was almost suckered into that same situation. I thank God everyday that I didn't sign my existence away. Now that housing is taking such a hit, I predict a buyers market with straight forward fixed interest rate loans. Hey, even banks get desperate eventually. Just think of all the forclosure homes they will be trying to off-load. Maybe I'm wrong, someone help me out here...

[MadHound]

20. Now we get to see what happens when two large forces collide

Human greed and corporate greed. It won't be pretty either.

Banks and mortage companies pushed these sorts of loans hard, especially over the last decade. They're great money makers for the lending institution, and by playing upon many peoples' desire to get the biggest possible house they can, live above their means on borrowed money, and keep up with the Jones', the banks had many willing suckers(err, I mean customers). Everybody thought everything was going to be all hunky dory until the reality of a housing bubble hit. Now the borrowers are being screwed to the point of no return by escalating interest rates, impossible payments, possibly an upside down mortage, and no way to get out from under it all. Banks are going to suffer because they'll be stuck holding a lot of real estate that they can't unload except for pennies on the dollar. Meanwhile, it will be you and I who will ultimately have to pay through higher interest rates, a sliding economy, and an ever dropping housing market. Yay:eyes:

Stick with the basics people, what works and has worked for years. Don't live beyond your means, don't strap yourself to a house payment that is larger than twenty five percent of your monthly income, and get a fixed rate, twenty or thirty year note. Yeah, it's not sexy, and you don't get to keep up with the Jones', but hey, when the Jones' have to unload their house for less than they paid for it, you'll still have yours.

I hold both parties responsible for this, the banks for handing these damn things out like candy, and consumers being stupid enough to fall for it. I damn near had to beat down the mortage officer when we bought our last house, he kept insisting that we should get into an ARM. After threatening to go elsewhere, he finally listened.