Buyer Beware, Borrower Beware

Buyer Beware… have you heard that before?

We’ve all heard the phrase “buyer beware” (Caveat emptor) which refers to an English contract law principle that dates back many centuries. The phrase means that buyers generally have less information than the seller about the product being purchased, therefore there is a situation of information asymmetry. Buyers should do everything possible to educate themselves about the product they are purchasing. A warranty can help to mitigate the information asymmetry, but in the absence of a warranty, the buyer must beware.

In the mortgage industry, the above principle is especially true as there are many short-term money lenders (I’m not thinking of private lenders) with advertisements like this: “Loans up to $35K, get cash as soon as today”.

Sound tempting? BEWARE!

I just completed a refinance for a client named Bob* and I want to share some details of his story to help you from making similar mistakes:

1. Bob was recently widowed and as he was attending to his wife’s estate, he discovered some unpaid debts and liens on the matrimonial home.
2. To clean-up the estate, Bob needed $32K.
3. He had $20K in credit card debts
4. He currently had a mortgage with a bank ($175,000; 25-year amortization) and his current monthly mortgage payment was $1,000.
5. As his mortgage was maturing in 2020, Bob thought that he’d go to a short-term moneylender for the $32K and then roll it into a new mortgage in a couple of months. He just wanted his wife’s debts paid quickly!

Here’s what happened:

Unfortunately, Bob approached a short-term moneylender and signed the following mortgage agreement:

• The mortgage rate of 26%
• Principle amount $32K
• The amortization period of 10 years
• Loan to value is 40%
• The fine print of the lender’s agreement disclosed the cost of borrowing and the penalty for an early payout (equal to 6 months’ interest)

Monthly payment = $725
That’s right: $725 per month for a loan of $32K!! Consider the absurdity of that 2nd monthly payment when Bob was currently only paying $1,000 per month for a 1st mortgage of $175K.

Bob’s Current Monthly Debt Payment is:

• 1st Mortgage (principle of $175K) = $1,000
• 2nd Mortgage (principle of $32K) with short-term moneylender: $725
• Credit Card Debt (Interest Only at 18% per annum) = $300

Total monthly cash flow to service debt: $2,025

Bob came to visit me and you can imagine the man’s distress. His wife had just passed away, he found some unpaid bills, and now he has just signed a second mortgage where he is paying $725 monthly for a $32K loan.

The Solution I proposed: Refinance

Bob had so much equity and $50K in annual retirement income. Here are the details of my proposal:

• Refinance the mortgage of $230K (His first mortgage of $175,000, his second mortgage of $32,000 and his $20,000 of credit card debt were all consolidated into one mortgage loan)
• 5 year fixed mortgage rate of 2.99%
• 30-year amortization

Total monthly payment of $966….a monthly cash flow savings of $1,059

Buyer Beware of the fine print

A couple of days before the closing day, Bob discovered a mortgage penalty of $4K from the short-term money lender. He says that he was verbally told by 2 people that the mortgage was open…however the fine print of the mortgage document did indicate a 6-month interest penalty (but this was not brought to Bob’s attention).

Bob was very grateful to me for the above solution and he repeated several times: “Why didn’t I contact you first?” It seems that the old saying of “buyer beware” is just as relevant today as it was in the 18th century.

Indeed Bob should have just refinanced first with a bank, or pure mortgage lender. His story also shows the importance of reading the fine print closely and seeking independent legal advice.

If you have any questions about your current financial / mortgage situation, please come and see me. I have access to over 20 mortgage lenders so there is a good chance that I can help you too.