June 29, 2006 at 6:00 AM ET
Today we are introducing a new monthly feature that I hope you'll find fun and educational – Truth in Advertising. I also hope you will participate and write in suggested topics. To get things started, here's this month's winner, concerning home loan offers that sound too good to be true.
"Have you ever heard of a mortgage rate of 1 ¼ percent? Yes, 1 ¼ percent!," the radio ads blare, crowding out box scores and trade talk on a very popular New York-based sports radio station. "An unheard of rate so low, you cannot imagine."
This advertisement seems the mark of great imagination. Here's more of one version of the ad, as supplied to MSNBC.com by the lender, Hall of Fame Funding.
"Hall of Fame Funding, one of the leading mortgage lenders in the tri-state area, has just secured funding for a special 30-year program …a 30-year rate starting at an unbelievable 1 ¼ percent. With an A.P.R. of …." The prevailing rate is then inserted by the anchor; for an adjustable rate loan, it would be closer to 6 percent.
But in each ad, the "1 1/4 percent" rate is repeated several times. In some cases, the ads are taped spots. In others, the well-known sports anchors read the ads Paul Harvey-style, lending them an air of credibility.
"Could this be true?" I thought to myself when I first heard the ad. Is there such a loan as a 1.25 percent mortgage? During a time of rising interest rates, everyone is looking for an edge. Perhaps Hall of Fame Funding has, as its advertising suggests, found some special money magic.
If there is such a low-cost loan, applying would be a no-brainer. I could load up on the cheap money, then buy myself some bank certificates of deposit at around 5 percent. My resignation would soon follow. Alas, as you can tell, I haven't quit my job yet. There is a catch. Listen closely, and you might hear that key word "starting." And you'll also hear the real interest rate, but you'll only hear it once.
So it's hard to ignore the repeated reference to a 1.25 percent loan. I decided to investigate.
What Eric told me
I called Hall of Fame to learn more. An operator named Eric took my call. He was encouraging.
"It's pretty sophisticated," he said. "You have to have a great credit score." But don't worry, he added, people who have scores in the 700s "can get away with murder."
I told him I was considering a $500,000 loan, like the one that the radio ads said I could get from Hall of Fame with payments of less than $2,000 a month. With a traditional mortgage, my payment on a loan like that would be $3,284, Eric explained. But he could sell me a $500,000 loan with payments at $1,786 -- a savings of 50 percent!
"I have this product myself," he assured me. "My payments were $4,100. They shot down to $2,100."
Using this loan I would save almost $100,000 during my first five years, and then I could afford a house in the overpriced New York City area, he told me.
But I was worried about this very interest low rate. "Is it really 1.25 percent that whole time?" I asked.
Almost, Eric said. He explained that the payments rise 7.5 percent each year, creeping up from about $1,800 to about $2,500 by year five. That's still a lot less than the $3,400 I could expect to pay with a traditional mortgage, Eric said.
"But what about the sixth year?" I asked.
"Hold on, Bob, I have another call," Eric said.
For a while, there was silence. Then, Eric got back on the phone and told me how likely it was that I'd refinance my mortgage before year six. Or that I'd move. And he reminded me that I would have saved $100,000 by then. He told me about a friend who bought a house two years ago for $430,000 that's now worth $730,000. Then he told me he couldn't calculate a payment because he didn't know what the interest rate would be in six years.
Humor me, I said. Let's say rates are flat. He still hemmed and hawed.
Finally, Eric said the payments in the sixth year would be about $3,600.
But that's hardly the worst of it. After a series of additional questions, Eric told me that as time went by, the actual balance on my mortgage would increase -- not decrease as it normally would -- after each payment.
Let me explain. During those heady first five years of easy loan payments, I'd be borrowing money from my home to keep those low payments that appear to be based on 1.25 percent interest. It's a process called negative amortization, a phrase that was as hard for Eric to say as it was for The Fonz to say "I'm sorry" on "Happy Days." In fact, he didn't say it. He simply did the telephone equivalent of nodding after I did.
Thanks to the negative amortization loan, I would actually own less of the home after five years than I did the day I bought it.
"Well, you figure something's got to give," Eric said.
What's going on here? I turned to an expert for an explanation.
Jack Guttentag is professor emeritus at The Wharton School of Business and runs the "Mortgage Professor" Web site. No one should shop for a home loan without visiting MTGProfessor.com.
Guttentag broke down Hall of Fame's claims for me. First, he explained that Hall of Fame Funding is hardly unique. He said he regularly receives e-mails from consumers bragging that they're paying miniscule interest rates like 1.25 percent for the first five years of their new mortgage.
Well, not quite. Think credit card teaser interest rates, only much worse. Homeowners with loans like these pay a minimum payment and the amount of their loans keeps growing, as with credit card revolving debt. There never really is a time when the consumer is spending only 1.25 percent interest to borrow the money. Rather, to make the payment "feel" like a 1.25 percent loan, the lender tacks on the added interest to the loan balance, a process called "capitalizing interest."
Here's the critical distinction to watch for: The 1.25 percent quoted in the ad is really the "payment rate," not the interest rate. In other words, it's the amount required by a calculator to keep your payments at that artificially low level. The difference is tacked onto the "back" of the loan, meaning after I start making payments, my $500,000 loan starts an upward climb.
That climb is capped at $550,000, Eric explained. But that's bad news, too. The moment the cap is reached, the monthly payment is immediately "recast." So I could face that $3,600 a month payment – or more -- sooner than five years in the future.
Guttentag had choice words for such mortgages.
"They are a nasty instrument," he said. "So complex that very few people really understand how (they) work."
Hall of Fame's 1.25 percent mortgage is not the cheapest teaser rate you'll find, by the way. A year ago, MSNBC.com wrote about the growth of exotic interest-only and negative amortization loans, and found one company selling something called 'The Stress-Free Mortgage" at 0.99 percent.
Guttentag called any ad that hawks a mortgage interest rate purporting to be this low "egregious." The industry calls these loans "pay-option ARMs." And as the days of rock-bottom mortgage rates fade into history, you'll probably continue to see ads across all media promoting mortgages with impossible interest rates like this.
So how can a company call a 6 percent mortgage a 1.25 percent mortgage? Aren't there laws against false advertising, and laws that mandate truth in lending?
There are. But even if a regulatory agency decided the ads were deceptive, mortgage brokers and mortgage bankers fall between the regulatory cracks, allowing them to walk very close to the legal edge. Federal banking regulators like the Federal Reserve or the Office of the Comptroller of the Currency don't have jurisdiction over mortgage bankers and brokers. Instead, state banking supervisors do.
In the case of Hall of Fame Funding, that would be the New York State Banking Department. Agency spokeswoman Elizabeth Billet pointed me to the federal Truth in Lending Act, which requires lenders to state the annual percentage rate when describing loan interest rates. What's unclear from the act is this: Is it within the law to mention one rate multiple times (in this case, 1.25 percent), and mention the true rate – the annual percentage rate – once?
My next step was to call back Hall of Fame Funding and ask what the company thought of all this. When I called, I was eventually passed to the company's president, Dan LaRosa. The Hall of Fame Funding name was actually created to attract sports fans, he said. Initially, the company tried a cable television campaign with former New York Giants great Lawrence Taylor. That didn't work well. But the sports radio ads have been very successful, he said.
"We've gotten a lot of hits," he said. "We are able to help people."
LaRosa said the 1.25 percent mortgage "affords certain people the ability to move into something that they can afford the payments on," and works for people who may be moving in a year or two. Eric, LaRosa's employee, had earlier told me there was a prepayment penalty for paying off the loan within three years, but LaRosa said that wasn't always the case.
He also said borrowers pay 1.25 percent interest on the money during the first five years, with only fractional increases once per year.
Strictly speaking, that's true. But also strictly speaking, consumers are paying much higher interest rates for the money along the way -- they are simply paying with debt rather than paying with cash.
When I asked LaRosa if his ads were deceptive, he said he wouldn't answer any more questions over the phone. He asked me to e-mail questions to him. I did. Then his lawyer wrote to me.
'Not one consumer expressed confusion'
"The ad was not deceptive," said attorney Howard Newman in an e-mail. "I am informed by my client that other than your inquiry, not one consumer has expressed confusion or alarm upon responding to the said ad and conferring with a loan counselor."
Newman went on to make the point that the ad clearly states a "30-year rate starting at an unbelievable 1 1/4 percent – stressing the word "starting" -- and that the annual percentage rate is revealed soon after.
"Quite clearly, this was disclosed as an adjustable rate mortgage," he said. "Otherwise, the language 'starting at' would have been inappropriate and misplaced." Consumers can also choose to make more than the minimum payment each month, which would prevent the loan from negatively amortizing, he said.
In an interview, he defended use of the payment rate in advertisements, saying that the primary concern of most consumers is the amount of their monthly payment.
He did concede that the 1.25 percent mortgage is "a complicated loan product," difficult to fully explain in a 15 second ad. But such low-interest loans with teaser rates are popular with consumers, who are more sophisticated than many believe, he said. And before they sign for a loan, consumers receive a variable rate program disclosure and a payment schedule explaining what really happens to their money.
"You'd be hard pressed to find a consumer who understood (the ad to be an offer of ) a 30-year fixed rate at 1.25 percent," he said.
Regulator: 'It could be more clear'
Armed with a copy of the radio advertisement provided by Newman, I went back to the New York State Banking Department. After reviewing it, the agency contacted Hall of Fame Funding and said the advertisement needed clarification.
"It's not illegal," said Billet, the spokeswoman. "But it could be more clear." She pointed out that in the ad, Hall of Fame mentions a 1.25 percent rate twice before adding in the qualifier "starting at 1.25 percent." Billet said the agency has "instructed" the company to make changes to the ad.
But how can this company spend three months claiming to sell a 1.25 percent mortgage on the radio without stating just as often that the real interest rate -- the annual percentage rate -- is much higher?
Oh yeah? Make me!
The answer is a question: Who's going to make them?
The New York State Banking Department can -- and does - investigate consumer complaints. But it has no authority to prosecute. Instead, when the agency finds egregious cases or gets a flood of complaints, it must take a number at the New York attorney general's office and ask Elliot Spitzer to prosecute. Of course, only the choicest, noisiest cases rise to that level.
The Federal Trade Commission also can enforce Truth in Lending Act rules or truth in advertising rules through civil cases, but resource constraints mean it only targets regional mortgage brokers and bankers that are generating a lot of complaints, said Mary Engle, associate director of the Division of Advertising Practices.
Truth in Lending rules can be found in Regulation Z, written by the Federal Reserve Board as an extension of the Truth in Lending Act. Sadly, they are rarely enforced against mortgage brokers, says John Burnett, editor of BankersOnline.com.
"The only people who are effectively, proactively monitored for compliance are banks and other financial institutions because they have a regular regulator who comes in and looks," he said. As a result, "There are advertising requirements (mortgage brokers) are ignoring."
So that leaves it to you.
Of course, you can vote with your wallet and simply ignore ads that sound too good to be true. Better still, New Yorkers who believe a banking-related advertisement is deceptive can report the company by calling 1-877-BANKNYS. Those in other states can look up their state banking supervisor on the Internet, or fill out a complaint at FTC.gov. And of course, you can also complain to the media outfit that ran the advertisement.
And finally, you can complain to me. Truth in Advertisements will be a regular feature on the Red Tape Chronicles, and I'm taking submissions for July's entry and beyond.
Send in your nominations. I'll try to chase down the truth of the matter, and I'll also ask: Isn't someone responsible for enforcing truth in advertising rules?
Of course, I'll have to keep the topics interesting to a national audience, so I will avoid advertisements that are purely local. But something tells me I won't be lacking for material.
Now it's your turn to have the last word. Either post your candidates below, or write them to me privately at BobSullivan@feedback.msnbc.com