| Nearly a year ago then Chairman of the Federal | | | | great loans for the right type of borrower. (I have since |
| Reserve Alan Greenspan warned of the "potential for | | | | changed my mind on this; I don't think there is a right |
| individual disaster" from newer more flexible | | | | type of borrower for this product. Too many people |
| mortgages. Although he was referring specifically to | | | | use only the minimum payment option. As many as |
| "interest only" and "pay option ARMs," which are often | | | | seven out of ten borrowers with these loans use only |
| conflated, he was concerned that consumers were | | | | the minimum payment according to UBS.) They |
| not being made to understand the true nature of these | | | | typically allow you the flexibility to make one of four |
| mortgage products. Toward the end of this past | | | | types of payments, a 30-year or 15-year amortized |
| September Federal regulators finally began to address | | | | payment, an interest-only payment, or lastly a |
| this issue. I am of the opinion that Federal regulators | | | | negatively-amortizing payment. It is the last of these |
| are far too late on this one. They might as well be | | | | payment options that have the potential to be |
| rearranging the deck-chairs on the Titanic and any | | | | dangerous if the borrower does not understand how |
| regulation that comes will be cold-comfort for many a | | | | they work and this is the 1.00% that is advertised. |
| homeowner as the housing market continues to cool | | | | So what is the truth, it is a great payment is it not? |
| around the country. | | | | Yes, it is for a short time, but you are not really getting |
| I personally do not think that "interest only" ARMs | | | | a 1.00% mortgage. What you are actually getting is a |
| presented nearly as much risk to the consumer as the | | | | rate based on an index such as the cost of funds |
| "pay option ARMs" did and have been of the opinion | | | | index plus a margin and the 1.00% payment you are |
| for some time that this product borders on criminal. | | | | making is only a portion of the actual interest due, the |
| Before I delve too much deeper, I'd like to step back | | | | difference (negative-amortization) is added to the |
| and explain specifically how the product works. A | | | | principal balance of the loan thereby increasing the |
| typical Option ARM, as we call them in the industry, | | | | amount you owe. For example, say you have a |
| has up to four payment "options" every month, a | | | | $200,000 mortgage and your current fully-indexed or |
| minimum payment, an "interest only" payment, a | | | | actual interest rate is 6.972% the payment should be |
| 30-year amortized payment, and a 15-year amortized | | | | $1326.00 per month. If you made the 1.00% |
| payment. The last three payment options listed above | | | | negative-amortization payment for the same loan of |
| are calculated based upon a typical ARM structure | | | | $643.00, the $683.00 shortfall ($1326.00 - $643.00 = |
| that being a margin over a specific market index, e.g. | | | | $683.00) is added to the principal balance. So after you |
| "monthly treasury average" plus 2.25%. It is the first | | | | have made your payment you now owe $200,683 |
| option that is the most deceptive since it does not | | | | instead of $200,000. What you owe is actually going |
| cover the actual amount of interest due what is | | | | up not down. Compound that over several months or |
| referred to as negative amortization and I don't think | | | | years and soon you have added thousands of dollars |
| that most people understand this. | | | | to your mortgage." |
| My issue with these mortgages is not so much about | | | | Okay, so if the said example above was based on a |
| how they work. It is really about the way they were | | | | mortgage of 95% of the value of the home and you're |
| marketed. Most of these mortgages were marketed | | | | in a market that is seeing any kind of downturn, guess |
| by brokers and wholesalers as a way to get into an | | | | what? You're upside-down on your home very quickly |
| otherwise unattainable home by keeping the initial | | | | since the unpaid interest is added back to principal. |
| payments artificially low. You could not pick up the | | | | Once principal exceeds 110 percent or 115 percent of |
| paper or listen to the radio for a long time without | | | | the original loan, the minimum-payment option goes |
| some broker shilling the "1% mortgage." They | | | | away. Borrowers are then faced with a payment |
| conveniently left out the part where the 1% does not | | | | double or triple the minimum. The really brutal thing |
| cover the true interest of the loan and your monthly | | | | about these mortgages is that most come with a |
| payment actually increases the amount owed on the | | | | "soft" pre-payment penalty of some sort, meaning |
| loan at the end of the month. For this reason alone I | | | | they cannot be refinanced without a hefty penalty of |
| argued in CORE over a year ago that most | | | | some sort, usually two or three percent of the loan |
| homeowners should avoid these mortgages, because | | | | amount. And some loans even have what we in the |
| the risks are far greater than they understand. As | | | | industry refer to as a "hard" pre-payment penalty, |
| delinquencies and foreclosures increase around the | | | | meaning you cannot even sell the property without a |
| country we are just now seeing the tip of this iceberg. | | | | heft pre-payment penalty. So again, just to hammer |
| Those markets that saw the most speculation are | | | | home the point, you have a great many homeowners |
| about to take it really hard. Studies have shown that a | | | | that are already upside-down on the mortgage, the |
| large number of borrowers with simple ARMs don't | | | | mortgage adjusts upward and they can't afford to |
| understand the terms and underestimate the amount | | | | refinance or sell because they would have to bring |
| their mortgage payment could increase; nontraditional | | | | money to closing and they can't afford to make the |
| ARMs are even more complex. | | | | payment. Although the Denver market did not see that |
| By now, it should be evident for nearly everyone that | | | | a great many of this type of mortgage I have still |
| the housing market is coming to a screeching halt in | | | | spoken with many a prospect lately that was in one |
| the most overheated markets. Some economists | | | | and could not refinance out of it. Oh, and did I mention |
| have predicted price fall-offs of up to 15% in some | | | | these loans are heavy commission loaded? |
| regional markets which is why I feel Option ARMs are | | | | So what options do you have as a homeowner if you |
| so dangerous. I'll illustrate this for the most overheated | | | | have one of these loans? The best thing is to make |
| markets, starting by quoting myself from a CORE | | | | sure you are making more than the minimum payment. |
| article I wrote about a year ago. | | | | If you are not, begin to as soon as you can, preferably |
| "Beware of the 1.00% mortgage. Trust the old saying, | | | | the 30-year amortized payment listed on the monthly |
| 'If it sounds too good to be true it probably is.' This | | | | statement. It might be a stretch at first, but it will begin |
| holds just as true in mortgage lending as with anything | | | | to nibble away at the principle balance of the loan and |
| else in life and I can guarantee you that there is no | | | | put you into a better position if you need to refinance. If |
| such thing as a one-percent 30-year fixed-rate | | | | it is too much of a stretch to make the 30-year |
| mortgage. Furthermore, there is no such thing as a | | | | amortized payments try to make at least the interest |
| one-percent six-month, one-year, three-year, five-year, | | | | only payment. If all else fails it might be worth speaking |
| or seven-year adjustable rate mortgage or ARM | | | | to a mortgage professional about refinancing into |
| either. So you are asking yourself, 'What was that ad I | | | | something fixed. In many cases actual 30-year fixed |
| saw in Sunday's paper talking about then?' The | | | | rates may be lower than the rate referenced on your |
| answer is simple; it is an option-ARM and they are | | | | monthly statement. |