Option Arm Loans: Good or Bad Loans? February 5, 2008Posted by shaferfinancial in Uncategorized.
Tags: mortgage planning, mortgages, option arms, real estate, Wealth
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.