My sister-in-law is in this new at-home pyramid-type business. One of those where you invite people to your house and give a presentation. Then get them to invite their friends, and so on. Or you could become and agent, and then convince others to be agents, and so on. Only it’s not selling vitamins, cleaning supplies, or drink mixes… it’s convincing people to re-finance their home loans!
The presentation goes as follows:
Reduce your monthly payment (their papers showed about 30%)
Get a boatload of cash; pay off your debts (they really play up this part)
And then…
Use remaining boatload for a down payment on a new larger house (with pictures of your new larger house)
Rent out your old house at market value. Since that house has a lower payment (see #1), use the difference to help pay the mortgage on your new house
I see a few catches off the bat. The lower payment scenarios are only for the next 5 years. Then what? “Refinance again” (but interest rates may go up).
I need to buy a new house within 6 months, or that boatload (#2) gets taxed. What if I cannot find a renter? That means I pay both mortgages, right?
It sounds like 3 loans. I have my current loan, then the new loan based on the refinance, and a new loan for the new house.
I have since told her I’m not interested. Nor do I want to alienate my friends and neighbors by inviting them to a pyramid presentation. Plus, if I ever want to refinance, I’d rather go through, oh, an established financial institutions run by experts, than be hard-sold after viewing a powerpoint on a dinner table. I did ask about this, and got the “non-personal corporations are evil” type speech.
I was thinking about doing this a pit thread, since my sister-in-law keeps bothering me about signing up (or getting my friends to sign up). But I found myself genuinely curious how this refinancing works. Is this really a scam (as is my prejudice toward all Amway-type presentations), or is this how real refinancing works; only done at a more personal level?
Your scheme doesn’t say anything about the actual details of refinancing, aside from “do it”. Everything else(bigger house, paid off debts, etc) is just stuff you do with the money you get from the refinancing.
Sounds like they’re pushing some kind of 5-year ARM. Every person on the face of the earth with a mortgage gets tons of these offers every month for the same thing. I could heat my house by burning those letters.
There’s no magic about those things - you’re getting a low interest rate for a few years but then your payments go way up. Any decent mortgage website or “Home Buying For Dummies” will explain how those work and let you figure out your payments on a year-by-year basis.
kawaiitentaclebeast
Here’s an old email the SiL; don’t know if this will help. Like I said, I’m NOT doing any refinancing for the time being, nor am I asking for financial advice. I just want the straight dope on what the SiL is talking about.
The numbers aren’t real, but I tried to at least estimate the percentages. I probably got it wrong, but I don’t think the numbers are important. Besides, $400K wouldn’t buy a nice house out here anyway.
Parenthesis are mine.
Valguard, 5-year ARM? It sounds like her plan should be avoided. You’re saying the payments go way up after the 5th year? Is that the reason to avoid it?
It’s not the worst refinancing scheme I’ve ever seen, but it isn’t the best, either. What concerns me is that it’s a thinly disguised “how to become a real estate billionaire with other people’s money” scheme.
There are two cliches you need to remember.
You can’t get the reward without the risk
Refinancing your home with an ARM involves some risk. Using the money to buy rental property expecting the revenue from the rental will pay off the mortgage involves considerably more risk. Which leads to the second cliche.
Hang on a sec… “you have a deferred interest here”??? Maybe I’m being completely dense here and not understanding something important (it would certainly not be the first time) but is this a negatively amortizing mortgage? It seems to suggest it to me, if the “minimum payment” is less than “interest only.” Again, I could be completely missing something here.
If a family member or so-called friend tried to hard-sell me a partial interest only mortgage right now, I’d probably kick them somewhere painful.
kunilou’s advice is extremely sound in my opinion.
It sounds like an ARM or some other variety of mortgage with low initial payments. There’s a bunch of them but what they all boil down to is “We’ll give you a really low rate up front and then you’ll have to pay a lot more later to make up for it”.
An ARM is an Adjustable Rate Mortgage; you get some very low initial rate that’s good for a few years (say 5 years) and during that time you aren’t paying much compared to my 30-year fixed rate mortgage.
After that initial grace period is up the rate is adjusted to meet some market index rate (might be something you have heard of or it might be something exotic like the Norwegian Lutefisk Bond Rate) and generally that means that your interest rate goes up. There are usually limits on how fast they can increase the rate and the maximum it can go, but you can still wind up paying more than you would have with a normal fixed rate loan.
There are also things like “interest only” loans where for a while you are just paying interest. Sure your payments are low but that’s because you aren’t getting any equity in your own property. Then down the road you get larger payments because you’ve still got to pay off all that principal that you haven’t been putting money towards.
It seems to me that a lot of these loans are aimed at people who want to buy a bigger house than they could otherwise afford, and they are hoping that the property will appreciate fast enough that they can pay off their big mortgage in a few years, before their interest rate or payments go soaring upwards.
My 30-year fixed may be dull and staid but I know to the penny what I have to pay every month and it ain’t changing, no surprises. It was within my budget when I bought my house and since I’m not planning on earning less over the years it’ll stay that way. I have friends who bought expensive condos on ARMs a few years ago and now they are facing the fact that they couldn’t really afford the place to begin with - since their interest rate is about to go climbing up into the sky they will have to sell, hopefully having made enough profit through appreciation to cover all their closing costs and moving costs and whatnot.
Nope, you got it in one. It sounds like the deal is: refinance your primary residence to pull out your equity, and turn your mortgage into a negative amortization loan. With that boatload of cash, buy a new house. Rent out your old house, and use the rental payments to (1) pay the mortgage on your old house (which, since it’s negative amortization, is only pennies on the dollar); (2) pay off other debt; and/or (3) pay your new mortgage.
There is nothing good about this scenario. Other than the temporary wish-fulfillment.
Yup. And if interest rates fluctuate (as they are wont to do), sometimes they’ll be better than what I have, and sometimes they’ll be worse. But as a risk-averse person, I’m okay with that.
If housing values decline, someone doing this will GET KILLED.
They are heavily LEVERAGED. The big “out” for them is that they hope they can sell for a profit if they are in over their head when the “real” interest rate kicks in. Well, at this point in the game, who are they going to sell to? Housing values are declining. The “greatest fools” have already bought.
A report came out last week that we had the first year-over-year decline in median sales price since 1991.
When your sister starts selling mortgages at the kitchen table, that’s a pretty good indication that the party is over.
Yeesh. It’s one thing to buy some candles, or stamps, or lingerie, or kitchen gadgets at one of these things. Heck, even agreeing to sell candles, stamps, lingerie or kitchen gadgets isn’t so bad…you might even make enough money selling the stuff to finance your purchases of candles, stamps, lingerie, or kitchen gadgets from your parent company. And if you work really hard you could easily make minimum wage (or even higher!) at this sort of thing.
But mortgaging your home to buy a more expensive home and rent out your first home?
People are going to get killed on this. You’re basically taking all the equity (if any) you have in your house and investing it in a rental property (the fact that your rental property is the house you’re currently living in is irrelevant), then paying less than the minimum on your house?
How much do these people think they can rent their house for? Rental prices haven’t kept up with house prices…housing prices have gone through the roof, but rental prices haven’t. So if you buy one of these insanely expensive houses you almost certainly aren’t going to be able to pay the mortgage by renting it out. The only way to make money on an insanely expensive home is to resell it to an even greater fool. But the population of greater fools is getting a bit thin nowadays.
The basic point here is that lenders are not fools. If they can earn, say, 5.25% lending money out to people like me on a fixed rate mortgage, why would they lend that money out to someone else at, say, 3%?
The answer is that they won’t. They might do 3% for the first few years but then the rate will go up so that over the long term they earn as much (or perhaps more) as they would lending it to me at 5.25%.
That’s how all those ARMs, interest-only, negative amortization and other such loans work - low payments now, higher payments later. Works out great for the lender in the long run but it can kill the borrower if they weren’t really thinking beyond the initial period.
The type of loan appears to be what is called an “option ARM.” That is, it’s an adjustable rate mortgage, and you have the option of paying less than the interest (for a while).
These are exceptionally risky loans, and I agree with what everyone has said here. One more thing (that I don’t think anyone has mentioned) is that, while the ARM will reset to current interest rates after a set period of time (usually 1, 3, 5, or 7 years), the “option” part, that lets you pay less than interest, will typically reset at that time or when the money borrowed exceeds the value of the property by a certain amount, whichever comes first. Usually, this reset will happen when the mortgage is worth 110-120% of the current market value of the home. At that point, you typically have to start paying interest and principal on a 30-year payoff schedule.
So, in a declining market, not only will you get creamed by leverage, you also won’t even have as long to stay afloat. If property values go down by 10% or so in the next year (and in lots of markets, there’s a good chance they will), that 5 years you thought you had will vanish. You’ll have to start paying full interest plus principal very soon, which will more than double your mortgage payment.
I don’t know how these things work out in the US. But the experience in Australia has been that when the chickens come home to roost and the suckers are in danger of losing their shirt, some of them have the remaining wherewithal to go and see lawyers. The next thing you know, they are suing those who (they claim) got them into the financial mess they are in by (they claim) telling lies as to the benefits and risks involved.
If I was one of the finance companies behind such a scheme, I’d think about laying off some risk by outsourcing the selling of these dodgy products to someone like, oh, your sister in law, perhaps.
Or so we hope. If property values fall below what’s owed, then homeowners will start to default and lenders who cooked up those cute financing schemes won’t look quite so clever as they once imagined themselves to be.
I assume that interest, closing costs and so on also include some allowance for the fact that a certain percentage of loans will default, they at least reduce their exposure to that problem. Generally speaking riskier loans have higher interest rates.
And they do still get the house so it’s not like they’re out the full value of the loan, just the difference between the loan and whatever they get on the foreclosure market.
I agree that if this happened en masse then some of those lenders would find themselves in deep poopoo.
Something like this contributed to the S&L bailout back in the 80s – tons of shitty loans. One worries that we, the taxpayers, might end up on the hook for a few hundred billion again.
This bubble is WAY bigger than any bubble back in the 80s, though.
I hate to be the one to break the news to you, but you do realize you’ll have to kill her now that she’s infected with the Amway bug? Really, it’s the most merciful thing you can do. The SIL you knew is gone. The body that remains is not at rest. Help her spirit with the transition to the next world by killing her. Preferably immediately. Before the plague spreads.
Are you sure this kind of deferred interest (negative amortization mortgage) is even available on an investment property? If you are taking out a new mortgage on your home in this fashion, you are probably representing (or agreeing) that the property will be owner-occuppied.
What if you can’t?
This is very risky, as others have said.
Essentially, you are starting a business and financing it in a very risky way. You’ll have no insulation from liability (you aren’t forming a business entity to do this, right?). If a tenant sues you, you may be personally liable (you might have insurance, but it doesn’t cover all possible lawsuits). Also consider the costs of becoming a landlord. Will you be able to make both mortgage payments if a tenant flakes? What will it cost to insure the leased home? Do you have the time and money to evict a deadbeat tenant? What if the tenant trashes the place, will you have the funds to fix the place back up quickly so that you can re-rent it?
Aside from the aspect of the crappy loan arrangement . . .
Do you really want to be a landlord? Do you have any concept of the headaches involved. Finding a tenant, maintaining the place, tenants not paying, evictions, the place getting trashed, security deposits, the place sitting vacant while you have to make the mortgage payment, complaints, headaches, headaches, headaches.
For me, no thanks. If you want to be a landlord there are better ways of going about it.
Basically, the idea is to heavily leverage your existing home equity into the real estate market.
During the past couple of years, when real estate prices were going up at double-digit rates in many markets, this was generally profitable (which is why more and more people got into it). However, if real estate prices go down (as they seem to be doing now), anyone who’s bet their home equity on this scheme is going to end up big-red-capital-Superman-“S” screwed.