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Option Arm Loans: Good or Bad Loans? February 5, 2008

Posted by shaferfinancial in Uncategorized.
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West Coast Banks like World Savings, Washington Mutual, Countrywide, and others have originated and propagated option arm mortgages.  In short a option arm is a short term variable rate loan that recalculates the rate frequently based on the “COFI Index.”  This index represents the rate depositors are paid for savings accounts in the 11th District.  Most of these loans are sold with a lower “teaser” rate that is only good for a short period of time.  In addition to the variable nature of the loan, 4 payment options are given.  These usually range from negative amortization payment to a 15 year amortized payment.  Most people that have this loan choose to pay the negative amortization amount.  This means that every time they make a payment their loan amount is increasing.  Popular in California, the underwriters allowed folks to qualify for these loans using the teaser rates.  In short, you could buy a more expensive home using this loan than the other types of loans.

The people selling these loans usually advertised the payment rate and kept the actual interest rate from the consumer as long into the process as they could.  There is a reason for this.  Because these loans are considered higher risk loans, they had a higher underlying interest rate.  This “premium” was anywhere from 1% to 3%.  Now in order to make these loans seem less expensive than they were, and to add to the profit mortgage originators made, almost all option arm’s were sold with a 3 year pre-pay penalty.

One final comment on these loans.  When the loan value went up to 110% of the original value the negative amortization payment rate drops off and your required payment moves to an amortizing payment rate.

Now here is what is happening to folks with these loans.  They have seen their loan amount go up, their real estate value go down, and their payment rate go up.  If they tried to get out of these loans they were hit with the triple whammy.  Pre-payment penalties of 6 months interest, little or no equity left, and debt to income ratio’s that are too high for conforming loan standards.  In short, they are stuck in a very expensive product that has a much higher interest rate than they could have qualified for at the time of their loan.

I have never sold an option arm loan.  I think they are too dangerous for most folks and too expensive to consider.  You make the decision for yourself what you think of these loans.  If you want one there are many folks who will sell you one, just not me.

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Comments»

1. dwfora - December 11, 2009

although you say that Option Arm Loans are too dangerous, these types of loans are actually quite useful for people that are smart investors, have declining rates and payments, and can be modified by the person involved in this type of loan. for more information, please read the following article:

http://www.bankapedia.com/mortgage-encyclopedia/faqs/674-advantages-to-the-option-arm

shaferfinancial - December 11, 2009

Wells Fargo who bought all of Wachovia’s loans including a healthy dose of option arms have stated that their option arm loans are defaulting around 40% which is much better than the overall profile for option arms. Can they be used for short term benefit? Yes, but what we are seeing is what happens when you get stuck in that option arm loan in a down re market. What is the premium now for an option arm loan? Can you even get one?? That would seem to indicate that they were too dangerous for folks and banks!

2. Debt - April 7, 2011

I’m glad that I’ve found this shaferfinancial.wordpress.com blog. You definitely can write and teach and inspire. Keep writing – I’ll keep reading.

3. Maybelle - May 25, 2013

This gives the fiscal institution the impression
that you just left behind all the past financial blunders, you’re debt-free, released from the previous bills and ready to adopt on new transactions. The faster you pay off the loan, the bottom will be the total amount of fees.


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