| I hate getting into technical mortgage topics and this | | | | However, the rule that the minimum payment rises by |
| one is even confusing formortgage professionals. | | | | no more than 7.5% a yearusually has two exceptions. |
| I got so many emails asking me questions about Pay | | | | EXCEPTION #1: Every five years the payment must |
| Option mortgages that I decided to go ahead | | | | be "recast" to be fullyamortizing. This means if you |
| andtackle the issue. Hang on tight!!! | | | | borrowed $300,000 and you now owe |
| You have probably seen the ads on TV. "Cut your | | | | $315,000because of negative amortization, the bank |
| mortgage payment in HALF!!!!" Get a $200,000 | | | | gets to recalculate the minimums tohelp them get |
| mortgage for under $400 per month!!" | | | | caught up, like described above. |
| It almost sounds too good to be true!!!! | | | | They will then recast it over the 25 years remaining |
| You have probably seen the ads in the newspaper. | | | | regardless of how large anincrease in payment is |
| Even more creative, theysound like the ANSWER to | | | | required. At some point you have to payoff your |
| your home-buying DREAM!! | | | | mortgage. |
| "1 Month Option ARM", "Smart Choice," "Smart Pay," | | | | If this happens your payment is going to increase |
| "Pay Option ARM," | | | | substantially, even theminimum payments. Your loan is |
| "Pick a Payment Loan", "Cash Flow Option Loan." | | | | for 30 years and at some point youhave to pay back |
| These are all simply well-branded names for what is | | | | the principal. |
| known as a "flexiblepayment ARM." | | | | Once again, if interest rates skyrocket, but you pay the |
| They may have different rules but nearly all share the | | | | minimum, you may begoing further into the negative. If |
| same main premise. | | | | they recast your loan, youmay no longer even be able |
| Lowest payment possible. | | | | to afford the "minimum" and be forced into arefinance |
| Even though you save money on monthly mortgage | | | | to keep your house. Or you may just lose it. |
| payments with this type ofloan, you can also lose your | | | | EXCEPTION #2: The loan balance cannot exceed a |
| some of your equity. | | | | negative amortizationmaximum. All of these programs |
| Here is how they work. Once again, each program | | | | have negative amortization maximums, whichrange |
| has slightly differentcharacteristics. I will discuss the | | | | from 110% to 125% of the original loan balance. |
| characteristics of the ones of which I am mostfamiliar. | | | | If the balance hits the negative amortization maximum, |
| Let's say you borrow $300,000. Each month you will | | | | the payment isimmediately raised to the fully amortizing |
| get a mortgage statementthat gives you the choice of | | | | level. Once again, the bankdoes not want to be too far |
| up to 4 different payment options. Each month | | | | upside down. In fact, these programs usually requirea |
| YOUchoose the payment you want to make. | | | | down payment of no less than 5%. More like 20% if |
| For example: | | | | you go with Stated |
| OPTION #1 will be the minimum payment. | | | | Income. |
| This will be the lowest payment based on the Start | | | | Either the recasting of the loan or the negative |
| Rate of your ARM. The firstyear this option will be a | | | | amortization cap can result inserious payment shock. |
| "teaser rate" that is good for between one to 12 | | | | I don't want to simply paint these programs in a |
| monthsand be the one like 1.000%. This minimum | | | | negative light. They have somevery real positives as |
| payment will change each year. | | | | well. |
| This is the one to be careful of. Making the minimum | | | | The main selling point is the low payment in the early |
| payment each month willvery likely mean you will end | | | | years. If you plan on onlyhaving this loan for 2-4 years |
| up owing more than you borrowed. | | | | it may the program for you. |
| When your loan is structured so that you can actually | | | | However you may be able to accomplish the very |
| OWE more than youborrowed it's called NEGATIVE | | | | same thing with a 1, 2 or 3year interest-only ARM and |
| AMORTIZATION. More on this below. | | | | not have to deal with the confusion. |
| OPTION #2 will be an interest-only payment based on | | | | Some borrowers find it an excellent way to manage |
| the ARM of the program. | | | | money because it allowsthem flexibility. |
| The program is usually is tied to very short-term | | | | Borrowers who work on commission, or who have a |
| Adjustable Rate Mortgage, like a | | | | lot of assets but minimalcash flow, may appreciate the |
| One or Three Month ARM. Although you get to make | | | | pay option programs. |
| an interest-only payment,plan on it adjusting regularly. | | | | It allows them to make minimal monthly payments |
| OPTION #3 will be a 15 year payment and will pay off | | | | when the cash flow is lowerand when the money |
| your loan as if it were a 15year payment schedule. | | | | starts rolling in, they can pay back deferredinterest and |
| OPTION #4 will be 30 year payment and will pay off | | | | pay down the principal balance. |
| your loan at the "Fully | | | | These programs are also great if you are in a |
| Indexed Rate" | | | | transition period that will mean youwill make more |
| Sounds great but confusing, right? | | | | money in the near future. For example, youstarted a |
| You should be confused. These programs are very | | | | new job and know that you are getting a pay increase |
| complicated, which createsan even greater danger | | | | in the next yearor so. This allows you to get in the |
| that borrowers will take them without fully | | | | house you want, make a very low paymentfor a few |
| understandingthe risks. | | | | years, and then start catching up. |
| I have had many clients come to me for refinances | | | | It's also a great program for disciplined borrowers who |
| who are currently in theseprograms from another | | | | want to pay off a lot oftheir equity. |
| lender. Not a single one understood the program | | | | I had one borrower who was selling his business and |
| andthey had been in it for some time. | | | | wanted to pay cash for hishome with the proceeds. |
| The problem is borrowers who don't understand these | | | | The sale of his business was delayed so he did |
| programs may somedaybe in a mortgage with a | | | | thisprogram until the escrow on the business finally |
| payment they simply can no longer afford. They hear | | | | closed. |
| "1.000%" and yell, "sign me up!!!" | | | | I had another borrower who wanted to pay down his |
| The scary about these programs is the negative | | | | house by $200,000 in thefirst two years. He did not |
| amortization part that thelenders do not quite explain | | | | want to pay any excess interest andthis was the best |
| properly. | | | | means for him to accomplish that. |
| Let me tell you how it really works so you can see the | | | | These programs allow borrowers to buy more costly |
| pros and cons. | | | | houses, or use the monthlypayment savings to pay |
| Let's say you love Option #1 and for the first 12 | | | | down other debt, improve their homes, or to use |
| months you pay the teaser rateof 1.00%. On a | | | | theirmoney for other reasons. They also give you the |
| $300,000 this is around $965 per month. Sorry you | | | | ultimate control over yourmortgage payment. |
| can't do thisas interest-only. | | | | However, as you can tell, they are risky. |
| When you locked the loan you did this using the | | | | The interest rate adjusts monthly, with no limit on the |
| Treasury as the index, and theprogram has a 2.75% | | | | size of interest ratechanges except a maximum rate |
| margin. | | | | over the life of the loan. The maximumsgenerally |
| The margin is the single most important thing to look at | | | | range from 9.95% to 12.500%. |
| when selecting a Pay | | | | Almost all of these programs use rate indexes that |
| Option program. It is usually higher than the rate itself | | | | adjust slowly to marketchanges. COFI is one such |
| and the lender cansometimes adjust this for you. | | | | slow-moving index, others are COSI, CODI and MTA. |
| Let's say when the bank sets your rate, the Treasury | | | | The bottom line is this.... |
| is at 2.350 that day. Addthe margin of 2.75% and this | | | | Don't be tricked by a low initial rate, it holds only for |
| means your minimum payment rate is 5.100%. | | | | one to 12 months. If youcan't afford the house without |
| The interest-only option for the same $300,000 loan | | | | the rate being 1.000%,you are in too much house. |
| would be $1275. | | | | An $800,000 loan at 1.000% is only around $2573/mo. |
| However you decide to take Option #1 that month and | | | | That opens the door fora lot more people to buy $1 |
| pay the 1.000% teaser of | | | | million homes. However can youstill afford the payment |
| $965. This means you would have "skipped out" on | | | | if adjustments cause it to go to $4000/mo. and |
| $310 for that month. | | | | beyond? |
| Banks don't like it when you "skip out" so they simply | | | | Like I said, you may be better served in a short term |
| add this to the backend ofyour mortgage. You now | | | | ARM that is fixed for at leasta couple of years and |
| owe them $300,310. $310 more than | | | | does not adjust monthly. One that alsowon't ever go |
| youborrowed....negative amortization. | | | | into negative amortization. |
| And this can go on and on. | | | | If you are in love with this program, please feel free to |
| They usually cap this at between 115-125% of the | | | | go ahead. They areextremely popular and people are |
| original loan amount. Thismeans that you cannot be into | | | | asking about them all ofthe time. |
| them for more than $345,000 on a loan you tookfor | | | | However, please make sure your preferred lender |
| $300,000 or they will "recast" or refigure the entire loan. | | | | understands ALL ofthe details. They all get the 1.00% |
| Did you get that? You borrowed $300,000 but if your | | | | part. That is what they are selling. |
| loan GROWS to $345,000,they get to automatically | | | | If your lender is not well-trained in this program and he |
| recast your mortgage. A "do-over" if you will. Only | | | | locks your margin toohigh or chooses a faster-moving |
| youdon't get another 30-year do-over. You get | | | | index it will cost you $1,000's yearly. |
| whatever time you have left with anew, much higher | | | | If you have to explain the program to him, find another |
| loan amount. | | | | lender for this program. |
| So you bought a $300,000 Pay Option mortgage | | | | Your focus should be first on the margin, because that |
| amortized over 30 years withfour great payment | | | | is what really determinesyour rate. |
| choices but after four years they re-casted it when | | | | Next look at the maximum rate. Look for one under |
| you got | | | | 10.000%, if available to you. |
| $45,000 in the negative. | | | | Your third priority should be total lender fees paid |
| So now you get a brand-new $345,000 Pay Option | | | | upfront. Lenders know youwant this program and are |
| mortgage with only 26 years left to pay. You can | | | | willing to pay for it. They maycharge more than normal. |
| imagine what that does to your new payment. | | | | Shop for the program that works best for you. Right |
| Negative amortization can be offset by home-price | | | | now we offer many differentvariations. |
| appreciation. That's anotherreason why it was so | | | | Banks don't re-price these programs every day with |
| popular when the market was hot. | | | | changes in the market, asthey do with other |
| However, if home prices drop, as they have recently, | | | | mortgages. Take your time and shop around. You |
| you could find yourself owing more than your home is | | | | don't haveto worry about locking these rates. They |
| worth. | | | | rise and drop monthly with the marketso timing it |
| It is far too risky for buyers to stretch to buy a home | | | | doesn't make much sense. You should shop margins |
| using a 1.00%mortgage, and then make a habit of | | | | and max rateson these. |
| paying only the minimum amount due eachmonth. | | | | Finally, like all loan programs, these programs come |
| Are you still with me? Barely? Well, here is where it | | | | with credit restraints. If youare planning on going Stated |
| gets really complicated.... | | | | Income, you probably need your credit score to |
| The minimum initial payment is calculated at the interest | | | | beover 680 to qualify. If you can go Full Doc, 620 will |
| rate in month one, andcan then, depending on the | | | | usually qualify you. |
| program, rise by as much as 7.5% of the start rate a | | | | If this program really interests you, you will also want to |
| year. | | | | consider the Secure Option ARM. Its the same |
| This means if the initial rate is 5.000%, it cannot go | | | | principal as above, and a little safer. |
| higher than 5.350% that year. | | | | The "natural" rate is fixed for five years and your |
| 7.5% of the start rate, not up 7.50%. | | | | option is to pay 3%-4% less than the natural rate. For |
| That is the yearly cap, so you really can get hurt too | | | | example, if the five year fixed rate is 7.000%, you |
| bad by the payment the first few years. | | | | have the option of paying 4.000% for up to five years, |
| While the interest rate jumps in month two, the initial | | | | or until the loan "recasts" at 115% negative. |
| payment holds for the year. | | | | Once again, for every $1 you pay under the 7.000%, |
| In the four years that follow, each minimum is 7.5% | | | | that amount is added to the bank end of your loan and |
| higher than the minimum inthe preceding year. The rate | | | | is negative amortization. |
| in month one therefore determines the | | | | At the time of this newsletter, the average Pay Option |
| minimumpayments for the first 5 years. | | | | ARM was taking about 32 months to recast, if you |
| That sounds pretty good. Sounds like you can't get | | | | make the minimum payment each month, while the |
| crushed. | | | | Secure Option is taking about 36 months. |