Payment option mortgages are all the rage in Southern California. With ridiculous purchase prices for homes up and down the coast, borrowers need a loan that can help them qualify for their high priced dream home. Along comes the “payment option ARM”, a loan that gives the consumer several choices each month for paying their mortgage back. This popular loan allows homeowners to make a payment for less than the interest accrued, and the loss of interest is added to the principal of the loan later. Lenders will actually add clauses to the mortgage note that contain parameters for the loan balance having the ability to grow up to 125%. These loans offer an initial period of reduced payments with deferred-interest. The payment option mortgage shifts the paying back choices into the borrowers hands. People have the ability to be responsible and make a responsible payment each month, so their loan is paid in full in 30 years, or they can risk their homes equity and make the minimum payment.
Fully Indexed Payment (principal and interest)
Interest Only Payment
Minimum Payment (negative amortization)
According to Bryan Wilson a mortgage broker in Orange County, “these loans offer increased purchase power for people because the introductory payments can sometimes allow borrowers to qualify for a home that would cost them $300,000 more with a traditional mortgage.” He continued, “Consider this…someone could get a million dollar loan for less than $3,500 a month. With a traditional 30 year fixed mortgage at 6.5% a million dollar loan would cost you over $6,300 a month.” That is a shocking payment difference that many southern Californian residents could not pass up. Critics have always voiced concerns about the implications that negative amortization loans could have. Mortgage bankers have countered with the argument that if your home increases 25-30% a year, then the downside of 5-10% negative amortization is minimal. With home property values soaring in the last five years, homebuyers in southern California have been earning equity in their home at a phenomenal pace. With that being said, you can understand why so many people are attracted to the payment option mortgage.
Recently some of the country’s leading bank regulators have issued concerns about home mortgage loan that have “artificially low starting payments.” John C. Dugan, the Comptroller of the Currency, spoke to a group of in Los Angeles last week regarding the risks of introductory rate loans. People need to realize that their initial low payments will increase significantly in time. Dugan continued, “After the limited initial period ends, the monthly payment for the holder of non-traditional mortgages must increase & even if interest rates stay flat & the size of that increase can be very substantial.” He noted that in some cases mortgage payments could increase a 100%. The bottom line is that people, who can’t afford their payment in the future, will be forced to sell their home. In some cases people will loose their home in a foreclosure. If the rate of foreclosure begins to increase rapidly, then mortgage rates could be affected adversely.
One major concern of the option arm mortgage is the restrictions for future subordinate financing. Frequently when people buy a home they don’t anticipate that they will need a second mortgage or home equity loan. The irony is that many of these borrowers are starting off with an adjustable rate second mortgage or line of credit. If you purchase a home with an 80-10 or 80-20 loan, the chances of you wanting to refinance the adjustable rate second loan are very good. Usually the interest rates on the second loan are significantly higher, and as the value of your home increases, you may want to refinance the loan into a lower fixed interest loan. When people get into a negative amortization first mortgage, they are very limited on financing a home equity loan. Most lenders will calculate the combined loan to value at the maximum potential of 125%. So you take your existing mortgage balance and multiply it by 125%, and then divide by your homes’ appraised value. If you are above 100% most lenders won’t extend you any home equity loan options.
We offer second mortgages behind negative amortization first loans, but the rates are higher, and the credit requirements are more demanding. If you plan on financing home improvements, buying furniture or consolidating debt, then I would not recommend the payment option mortgage.
Interest only mortgage loans make up over 25% of the mortgage market, which only accounted for 10% of the market share a few years ago. The popular payment option mortgages make up over 10% of the mortgage market, whereas 2 years ago it held less than 1% of the market share. The increased popularity has regulators reconsidering the disclosure process for adjustable rate mortgages. Whether you borrow money with a home equity line of credit or refinance with a variable rate mortgage, you need to realistic about budgeting your mortgage payment 6 months from now, as well as five years from now. Consider paying additional money towards the principal every other month. Ask your loan officer what the fully amortized payment would be for a shortened period, like 20 years. Every other month you should make that payment and you will come out ahead quicker. The additional money that you contribute to the principal will increase the equity in your home, and reduce the years you have to pay back the loan. If you have anticipate that you will not be able to pay additional money towards the principal, then you should consider borrowing less because if the housing market dips at all you could find yourself in some trouble.