Option Arm Loans -- Why the Bad Wrap?
By Bill Eatock
An Option ARM mortgage loan is a "Negative Amortization Mortgage," which means that if the borrower only pays the minimum payment each month the principal will build. By definition, a negative amortization mortgage is one, which has a low monthly payment that does not fully cover the accrued interest each month. Since the interest is not being fully paid, the difference between what is paid and the interest accruing is added to the balance of the loan.
Option ARM loans can be dangerous if the borrower is not prepared to refinance in a few years or is unable to accept higher payments. Lenders and brokers have an obligation to educate their clients to help them minimize the chance of future problems. Borrowers, like many uninformed article writers, blame the Option ARM Loan when in fact they should blame the loan officer for not educating them.
Article writers tend to use examples of individuals using Option ARM Loans for the wrong reasons. Folks that max out all of their credit cards every few years and suck out all the equity in their home to clear the balances are a prime example of wrong usage. When the market softens, these folks are guaranteed to fail if they continue their poor spending practices (i.e. not living within their means).
The fact that foreclosures are running 30% ahead of 2005 figures can be mostly attributed to these individuals, and those people that took on high loan-to-value (LTV) loans with high rates just to get into their home or investment property. Now they want to refinance into a Option ARM loan to get the payments manageable.
In California and Florida, property values have dropped more than the rest of the country; real estate equity is already running low. Owners that initially took 80% to 90% loans in the past few years are now sitting at a loan-to-value of 100% or higher based on current values. Consequently, they are unable to reduce their payments through refinancing and are stuck with a mortgage payment they cannot afford.
The big culprit in putting folks over their heads is not the loan programs, but the fact that borrowers can "state" their income to qualify. Although an Option ARM loan has a low payment over the initial few years, the borrower still must qualify as if they were going to pay the 30-year amortized payment. Because borrowers are allowed to "state" their income to the tune of often twice the income they actually make, they appear to be able to afford the amortized payment when in fact that amortized payment can be way more than they can comfortably afford. Also, if there is any ripple in their income stream due to injury or being laid off their job, they are in the red quickly.
About the Author
Bill Eatock is Owner of Investors Lending Group, a Mortgage Broker.
Who Uses Option ARM Loans? (for the right reasons)
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