1. The Option Arm Mortgage has a number of different names. It has been called the Option Arm Loan, Pick A Payment Loan, Neg Am Loan, and the Negative Amortization Mortgage. All of these names describe the same mortgage. All that really happened was that each mortgage company decided to change the wording of the loan so some sound better than others. Pick A Payment (wait, I can choose what payment I want to make) and Option Arm (we all like options) sound better than Negative Amortization Mortgage (nobody likes a negative Nancy). They all pretty much describe one of the worst loans ever invented and let me tell you why.
2. The Option Arm Mortgage came with a feature that let you have a choice on what payment you would like to make each month. You would get a 15 year fixed, 30 year fixed, Interest Only, and a Minimum payment. Every single month your bill would be calculated and it would tell you what you would need to pay to stay on track with what your financial goals are. If you wanted to pay it faster than make the 15 year payment. If money was tight then the minimum payment was what you needed to make and then play catch up.
3. The problem is that nobody ever played catch up with this mortgage. A many of mortgage brokers sold this Option Arm loan and made an absolute killing doing it. These loans could make a mortgage broker some crazy money on a commission because it paid double what a normal 30 year fixed interest rate mortgage does. Needless to say that there was an incentive for these loans to be pushed onto the home owners who were not educated in finances.
4. The major selling point of this mortgage was the minimum payment option and this is why so many people took this loan. As an example a home owner looking to refinance their $250k mortgage would take this loan because they were told that the interest rate they were paying was 3% even though it was actually 8%. Many mortgage brokers told potential clients that their interest rate was fixed at 3% but how this loan worked was that you were given a 3% payment. Of course this is all that the home owner hears after hearing from other mortgage companies that rates are higher. Sounds like a better deal so you took it. Your payments on a $250k mortgage at 8% are: 15 year = $2,390, 30 year = $1,834, Interest Only = $1,666, and Minimum Payment = $1,041. How the minimum payment is figured out is you take the actual interest rate of 8% – 3% = 5%. You figure out what the interest is on the payment at 5% and that’s your payment. It sounds too good to be true and it is.
5. What many mortgage brokers did not tell their clients is how this loan really worked. The Option Arm Mortgage did not have a fixed interest rate and interest rates were typically 2% higher than the normal 30 year fixed rate mortgage. The Option Arm loans typically had a huge pre-payment penalty during the first 3 years which was usually 3% of the balance if refinanced in the first year, 2% the second year, and 1% the third year. On a $250k loan with a 3% pre-payment penalty your looking at $7,500 in costs. Not good. The saddest part is that nobody was telling their clients that if they made the minimum payment the difference between that payment and the interest only payment would be rolled onto the back end of the loan. From our example of $250k that is $1,666 – $1,041 = $625. Let’s say that you make the minimum payment the first month. Next month your mortgage statement will show a balance of $250,625. I hope you can see how this number can grow very fast.
6. Many home owners took the Option Arm Mortgage because it was all that they could get approved on at the time. Many mortgage companies would qualify them based on the minimum payment and would give them the loan and then sell it after closing. The mortgage companies knew what they were doing and knew you could never afford the house after the neg am loan re-amortized. Re-amortized you say? What does that mean?
7. The Option Arm Mortgage came with a clause that let you defer up to 110%, 115%, or even 125% of the original mortgage balance before you had to start paying back the mortgage. Going back to the $250 mortgage and using the maximum 125% this means you could defer paying $62,500 in interest before you have to pay it back. Your new mortgage balance would be $312,500. Now you have a mortgage balance that is 25% higher than what you first borrowed ,i.e negative amortizing (not moving in a positive direction in paying the mortgage off). You can’t afford to make a payment higher than the minimum payment to begin with so there was never a month where you could pay even $5 more to the monthly mortgage payment. As soon as the balance gets to the maximum amount you can defer you have to start paying it back. You receive a letter in the mail from your neg am lender, probably Countrywide, Washington Mutual, or Wachovia (these 3 mortgage companies hold the most of these loans) saying your payment is going to be changing next month because you hit your 125% mortgage payment. You can’t believe this and you pass out on the floor.
8. After awaking you look at what your new payment is going to be like. The payment is now calculated at 27 years because you have been in the loan for 3 of the 30 years. You are required to make a principal and interest payment now and are you ready…I hope you are…cause its going to suck. You take the $312,500 mortgage balance, use 8% as your mortgage rate with 27 years left. Using a mortgage calculator you get a new principal and interest payment of $2,357.12. That is $2,357.12 – $1,041 = $1,316.12 higher than what you have been paying for the past 3 years. How are you ever going to be able to afford a payment that is more than double what you have been paying. The answer is there is no way.
9. After picking you jaw up from the ground and letting your hear rate slow down a little bit you get on the phone with your spouse and start thinking about options. You don’t have the money to make the mortgage payment so that does not help. Friends and family are going to throw an extra $1k at you every month for as long as you live in this house. Your only option is to try to refinance the Option Arm Mortgage. You call up your mortgage lender and tell them about the letter you received in the mail and how concerned you are. They don’t care because you did sign a document 3 years earlier saying you would pay this loan back. The customer service person forwards you to one of their loan officers who can maybe find out a new home loan for you. Since all of your information is in their computer system it does not take that long for them to bring everything up. Most loan officers dread looking at a credit report and seeing what the original balance was on your credit report and then seeing what it is now. Your credit report shows the exact date, original mortgage balance, current mortgage balance, and the exact month you may of had any mortgage lates. Many loan officers are already thinking there is nothing they can do for you now before you start telling them anything on your new mortgage application.
10. The reason no mortgage company is going to be able to refinance you out of your Option Arm Mortgage is because a lot or all of those loans have been eliminated all together. Option Arm Loans were considered sub-prime loans and nobody is doing them anymore. Even if you could qualify for a normal 30 year fixed rate mortgage at current 30 year mortgage rates around 6.5% with a payment of $2,054 on a balance of $325k your home is probably not going to appraise for what it needs to. During the refi boom, mortgage companies could do an Option Arm Mortgage at a loan to value (LTV) of 90%. If you deferred the maximum 125% you mortgage balance would be at 115% of the original value of the home. Home prices were going up everywhere at 15%-30% so in reality at that time the mortgage companies were betting your home would go up to. You would then still have 10% equity in your home to cover you in 3 years if you had to sell. Well, that just did not happen. At the end of 2007, home values across the country started plummeting at 5%-15% every month. Most homes across the United States have seen at least a 20% drop in what their homes were worth just a year ago. Some mortgage companies can do loans up to 95% as long as you are not taking cash out but in our example above you have already deferred 125% of the original loan meaning that you owe about 35% more than what the home is worth. No mortgage company is going to help you out now because if they do and you foreclose on the house then the mortgage note they hold is 30% more than what its really worth. This is bad business for an industry that is already hurting and nobody is going to refinance your Option Arm Mortgage. Your best bet is to try to get approved on a new home loan and buy a new, cheaper house before your current one goes into foreclosure.
That mortgage does suck. You are a very smart person.