Home prices have reached record
levels, and in many parts of the country, homes have become
nearly unaffordable. Real estate has replaced the tech stocks
of the late 1990’s as the hot investment, and everyone has
sold their stocks and jumped into investment property. Real
estate prices have increased at a far greater rate than salaries,
and the lending industry has attempted to solve this problem
by introducing a tremendous number of mortgage options for
borrowers who barely capable of purchasing a home. Most of
these loan types feature adjustable interest rates and minimum
down payments. One of these, the option ARM, is the most dangerous
type of loan ever introduced. Borrowers who are considering
an option ARM should be aware that this loan could leave them
with a loan that is worth far more than the home it’s used
to buy and with a loan that he or she cannot afford to pay.
The option ARM is not for the squeamish.
So what, exactly, is an option ARM? An option ARM is a mortgage
with an adjustable interest rate that typically gives the
borrower four different payment choices each month. The first
choice is based on a 30-year amortization table; the second
on a 15-year amortization table. These would correspond to
payments for adjustable-rate 30 and 15 year mortgages, respectively.
The third choice is an interest-only payment, which pays the
interest that accrues during the month but pays nothing towards
reducing the loan amount. The fourth choice, the one that
makes this loan so dangerous, is called the “minimum payment.”
The minimum payment is calculated upon the first month’s interest
rate, which is usually a very low “teaser” rate that can be
as low as 1-2%. Most borrowers with an option ARM opt to pay
the minimum payment each month, and that’s where the trouble
The loan carries and adjustable interest rate, and this rate
can adjust as often as every month. If the borrower is paying
only the minimum payment, then he or she isn’t even paying
enough to cover that month’s interest on the loan. What happens
then? The unpaid interest that has accrued is added to the
loan principal. The principal can actually grow larger, and
as interest due is calculated on the loan principal, the interest
due will increase, as well. Interest rates are currently near
all-time lows and are sure to increase. A buyer who continues
to make minimum payments on an option ARM will find that the
principal on the loan is actually increasing over time! This
is known as negative amortization.
In a negative amortization situation, only bad things can
happen. The lender can require refinancing under certain conditions
stated in the loan agreement. The buyer may find himself unable
to pay the loan and may have to default. And the lender could
find himself holding a note that is worth far more than the
house that it represents.
The option ARM is a loan that is best suited to investors
and homeowners who only intend to keep the home for a short
time. It is not a good choice for anyone who may be using
it to buy more home than he or she can afford. Unfortunately,
that describes a lot of buyers who are taking out this type
of loan. Anyone who is considering a home purchase should
be very careful if this type of loan is offered, as it could
leave you both bankrupt and homeless.
©Copyright 2005 by Retro Marketing.
Charles Essmeier is the owner of Retro Marketing, a firm
devoted to informational Websites, including End-Your-Debt.com,
a site devoted to personal bankruptcy, debt consolidation
and credit counseling, and HomeEquityHelp.com, a site devoted
to information regarding mortgages and home equity loans.