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Buyer beware

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Unsuspecting borrowers are often suckered into unfavorable loans with promises of low monthly payments or interest rates. Here are several terms that signal you could be entering a bad deal:

  • 228 ARM: An adjustable-rate mortgage that begins with a low "teaser" interest rate, which skyrockets after two years. After the initial period, the rate change increases twice a year—for 28 years. Unlike conventional ARMs, which fluctuate with interest rates, the rate never decreases.

  • 327 ARM: Similar to a 228, but the initial rate is in effect for three years, with semiannual increases for 27 years.

  • Option ARM: A particularly dangerous mortgage, it works like a credit card. Borrowers receive a monthly statement in which they can pay the full mortgage amount or a smaller "minimum" payment. Instead of paying off their home, borrowers who pay less than the full amount accrue more mortgage debt—like a credit card.

  • Deed in lieu of foreclosure: A borrower hands over the deed to their home to the lender and walks away. Although the borrower won't have a foreclosure listed on his or her credit record, it will list a failure to honor the mortgage, which is damaging. The lender doesn't have to go through a foreclosure proceeding and can seize the property more quickly. These transactions don't show up in foreclosure data, as they are not tracked.

  • Lease-back/buy-back options: A cottage industry of unscrupulous businesses has built itself on scamming borrowers who have been threatened with foreclosure. In a lease-back option, borrowers sell the home to a buyer for a deeply discounted price. The buyer pretends to takes over the loan, and may even make mortgage payments, but the sale agreement's fine print will later show the borrower still owns the house.

The buyer leases the house to the borrowers with the understanding that they may buy back the home later. The buyer raises the rent, evicts the borrowers, and leases the home to new tenants on a rent-to-own basis with a hefty down payment. The cycle continues as the rent is raised and tenants move out.

If at any point the buyer can't cover the mortgage, it doesn't matter—the home still belongs to the original borrowers, who unknowingly owe the mortgage—and the buyer walks away.

If you're planning to buy a home:

  • Ask people you trust who have bought or sold their homes, particularly if they have a long-standing relationship with a Realtor.

  • Ask a lawyer to read a mortgage agreement or "lease-back" if you feel uneasy about the terms. The attorney's fee is cheaper than a bad mortgage.

  • Seek help only from a HUD-certified counselor. These counseling services are free; if a "counselor" asks you for money, it raises red flags.

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