Newspaper article The Florida Times Union

Why You Should Learn Mortgage Mathematics

Newspaper article The Florida Times Union

Why You Should Learn Mortgage Mathematics

Article excerpt

Byline: Malcolm Noden

Maybe it's time to 'fess up that maybe we don't know enough about mortgages. After all, what harm is there in using some of that built-up home equity when the mortgage broker is willing to give us cash in exchange for a new, easily affordable adjustable rate mortgage?

What the broker probably did not mention is something called "yield spread." This term describes the difference between the interest rate you pay on a mortgage loan, and the lower interest rate that your credit would have allowed you to pay.

For example, if your credit was good enough for a loan at 7 percent, but you took a loan at 7.5 percent, the difference in the interest rates is called the yield spread. The lender earns additional interest on the loan without assuming additional risk, so this is a source of additional profit. Lenders often encourage mortgage brokers by offering cash premiums for loans with yield spreads.

In June, two respected economists published a paper about noncompliance by lenders with the Truth in Lending Reform laws. Here is part of their summary: "Consumer installment lenders prefer to market 'low monthly payments' and shroud interest rates ... We show that when an interest rate is not disclosed, most consumers substantially underestimate it using information on the monthly payment, loan principal and maturity. This 'fuzzy math' or 'payment/interest bias' helps explain why lenders shroud rates and thereby violate the Truth in Lending Act, even under the threat of fines and litigation ..." In Plain Speak, that means they found that most of us underestimate how much interest we would pay for a mortgage.

Our ignorance supports unscrupulous brokers and lenders who know there is huge money to be made from getting even a small increment in the interest rate on any mortgage.

Most of us will seek only one or two home mortgages in our lifetimes, and we believe ourselves secure in the existence of strong federal and state regulations. Thus, we rationalize that we don't need to understand all those complex mortgage terms. When the broker said our new mortgage involved, "A first with a 10-year ARM, with interest based on LIBOR, plus 100 basis points, and a second five-year ARM at LIBOR plus 200 basis points with negative amortization . …

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