Paul and Clare have decided to buy a house in Southern California, spending $ 400,000 in 2004. Thinking of selling it within 1 or 2 years would be inappropriate to take a mortgage loan for a period of 30 years. Then talk to John, their financial agent who offers him a loan 2 / 28 with zero down. It 'a kind of subprime mortgage in which there is a very beneficial agreement for the applicant in the first two years. Typically, the initial rate of interest, if any, is low and fixed for two years, after which the amortization schedule provides for an interest rate higher for the next 28 years (the rate is pegged to the LIBOR, London Interbank Offered Rate). In practice, this loan is sustainable only for those who are planning to refinance within the first two years later because the credit is set to rise dramatically. Bill and Susie are surprised by the fact that you can acquire an asset estimated $ 400,000 for nothing in return. Buy property, live a comfortable life, and after two years, they decide to sell their property.
Another couple, Joe and Cindy, who wants to buy the same house in 2006 is $ 600,000, are increasingly turning to John, the financial agent, and given that they also intend to sell it after a couple of years decide to enter into the same loan 2 / 28 Bill and Susie.
Now Joe and Cindy think they can sell their house after two years to $ 1 million under the current rate of appreciation. But begin to hear rumors of a likely collapse of the market. They call in the summer of 2007, a valuation and find that is only $ 550,000. We understand that will not be able to pay the amount as shall be amortized over 28 years with a higher rate.
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