Honey...I'm gonna buy the whole farm!!! ....just got me an OPTION ARM!!
It's disclaimer time again: all of these loan programs have their potential place in the market for RESPONSIBLE and knowledgeable people....and provided they are SOLD properly by the loan officer or broker. Some of what I'm going to say is just my opinion, and is does not necessairly represent how ALL option-arms are used/sold. There are lots of good brokers/loan officers (LO's) out there...BUT there are a lot that will do anything for the dolla-dolla-bill. My stories will focus more on saving bwrs from THOSE types of broker/LO's that I mention. The option-arm loan can get rather complex with the different indexes it is ties to, and each company does things a little differently. My overview is going to be the basics. Ok...lets get started!
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as seen on a billboard, in the newspaper, in a mailer you probably got at your house:
RATES AS LOW AS 1%!!!!!!
You are probably thinking..."HOT DAMN...I'm going to save some money!!" Well, lets take a look at things first.
The "option-ARM" is a popular loan that gives the bwr 4 payment choices each month:
- a 30 year amortization payment option
- a 15 year amortization payment option
- an interest only payment option
- a minimum payment option
So lets say you want a $500,000 loan (bear with my numbers here...for EXAMPLE only). Here is an example of what your payments could look like (assuming a 1% start rate, 5% I/O, 5.75 fixed...again, just using numbers that were realistic in the past...these numbers would depend on the index):
$ 2917.86 - 30 year amortization payment option
$ 4152.05 - 15 year amortization payment option
$ 2083.33 - interest only payment option
$ 1608.19 - minimum payment option
SO...which payment looks better to YOU?!?!?? That minimum payment looks pretty good!! How did they get the payment lower than the I/O payment?!?!? That's EASY...take the $475.13 you didn't pay...and tack it on the loan balance!!! So now, after 1 month, you owe $500,475.13 on your $500,000 loan. Pretty cool huh! Sure, you "saved" $475 today...but what did you do with it?!?!?!? Did you save it? put it towards retirement? get a bigger car payment? or buy more property!?!??!?
There are a couple of things to know about this loan...actually, there are a LOT of things to know about these loans, but I'm only going to cover the basics. Each company does things a little differently (margins, indexes, resets, recasts, guidelines, etc)...but at least I will give you an idea of what is going on.
--- Notice I said a 30-year amortization payment, not a 30 year FIXED payment. Each of these payments changes in regard to the underlying index. The 30 year payment will fluctuate with the index. The indexes that are used are usually the COFI, LIBOR, MTA and there are a few others. The companies will use whichever index is performing the best at the moment (the moment being when you GET your loan). There will be a margin on the loan. The margin is added to the index...and that determines the rate that you will pay.
--- So what is the "MINIMUM PAYMENT"?!?!??!? The minimum payment is that everpopular 1% or 1.xx rate that you see.
...but SAVE YOU A LOT OF MONEY!!!!
There is a LOT of money to be made on these Option-Arm loans. Brokers sell the "benefit" of the low payment...and bwrs jump in all to quick. Did you know that most lenders will pay 3 to 3 1/8's points back to the broker!?!?!? So that means...on a $500,000 loan, the broker will make $15,000....in ADDITION to any other "fees" charged. How did they get so much rebate?!?!? Well, they got the bwr a very nice 3 year pre-payment penalty. Sure, they could have done the loan with a 2, 1, or no pre-pay, but that does not pay the 3% rebate. A lot of brokers will say "I will hook you up. Pay 1 point origination fee, and the only way I can get you the 1% start rate is to take a 3yr pre-pay penalty. That means my fees are only $5000 which is less that what most people are charging". The bwr will agree...but not know they are getting $15,000 on the back from the broker by sticking them with the fat 3yr pre-pay penalty.
Can you believe that people end up paying over $20,000 to refi their house?!?!??! That is more than most people make in 3-4 months....and some "kid" working a phone made it in less than 30 days by putting in a few hours work. (yes, I know...not all brokers are kids, and not all brokers treat their bwrs with such disdain...but believe me, it happens more than you might think.)
I am starting to see things like this on credit reports (strictly an example that I saw): loan amount: $325,000 loan balance: $331,283 minimum payment: $982
So what that means is that the balance of the loan is higher than the loan amount...hence the term NEG-AM (negative amortization), and you see why...the $982 payment on $325,000. That "savings" has to go somewhere....and that somewhere is the back of your loan!
WHEW!! I hope that helps some. Again, not intended to be the most indepth overview out there...but should be enough to get the point across.
I do want to say that I do not know of a lender that will do an Option ARM to 100%. Most will do them for a max of 70-80% LTV, with 2nds or HELOC's behind them. These loans have their place for informed bwrs who are AWARE of the risks, and understand how they work. There are a lot of brokers that hate the loan even though it pays well. There are lots of brokers that DO disclose the "negative amortization" or "deferred interest" aspect of the loan...and make sure their bwrs know how risky the loan can be...and how payments can change. The reason I'm doing this blog...is so that people can be INFORMED and make the right decision for themselves. If they have to learn from the "pain" of others, or I have to point out the "misleading" ways things are sold, then I will do that. I sleep well at night...
Leave comments or send me e-mail. (socalmtgguy@gmail.com)
---------------------------------------
as seen on a billboard, in the newspaper, in a mailer you probably got at your house:
RATES AS LOW AS 1%!!!!!!
You are probably thinking..."HOT DAMN...I'm going to save some money!!" Well, lets take a look at things first.
The "option-ARM" is a popular loan that gives the bwr 4 payment choices each month:
- a 30 year amortization payment option
- a 15 year amortization payment option
- an interest only payment option
- a minimum payment option
So lets say you want a $500,000 loan (bear with my numbers here...for EXAMPLE only). Here is an example of what your payments could look like (assuming a 1% start rate, 5% I/O, 5.75 fixed...again, just using numbers that were realistic in the past...these numbers would depend on the index):
$ 2917.86 - 30 year amortization payment option
$ 4152.05 - 15 year amortization payment option
$ 2083.33 - interest only payment option
$ 1608.19 - minimum payment option
SO...which payment looks better to YOU?!?!?? That minimum payment looks pretty good!! How did they get the payment lower than the I/O payment?!?!? That's EASY...take the $475.13 you didn't pay...and tack it on the loan balance!!! So now, after 1 month, you owe $500,475.13 on your $500,000 loan. Pretty cool huh! Sure, you "saved" $475 today...but what did you do with it?!?!?!? Did you save it? put it towards retirement? get a bigger car payment? or buy more property!?!??!?
There are a couple of things to know about this loan...actually, there are a LOT of things to know about these loans, but I'm only going to cover the basics. Each company does things a little differently (margins, indexes, resets, recasts, guidelines, etc)...but at least I will give you an idea of what is going on.
--- Notice I said a 30-year amortization payment, not a 30 year FIXED payment. Each of these payments changes in regard to the underlying index. The 30 year payment will fluctuate with the index. The indexes that are used are usually the COFI, LIBOR, MTA and there are a few others. The companies will use whichever index is performing the best at the moment (the moment being when you GET your loan). There will be a margin on the loan. The margin is added to the index...and that determines the rate that you will pay.
--- So what is the "MINIMUM PAYMENT"?!?!??!? The minimum payment is that everpopular 1% or 1.xx rate that you see.
LISTEN UP!!!!!!!!
What I'm about to tell you here is going to PISS OFF A LOT OF BROKERS AND LOAN OFFICERS!!...but SAVE YOU A LOT OF MONEY!!!!
There is a LOT of money to be made on these Option-Arm loans. Brokers sell the "benefit" of the low payment...and bwrs jump in all to quick. Did you know that most lenders will pay 3 to 3 1/8's points back to the broker!?!?!? So that means...on a $500,000 loan, the broker will make $15,000....in ADDITION to any other "fees" charged. How did they get so much rebate?!?!? Well, they got the bwr a very nice 3 year pre-payment penalty. Sure, they could have done the loan with a 2, 1, or no pre-pay, but that does not pay the 3% rebate. A lot of brokers will say "I will hook you up. Pay 1 point origination fee, and the only way I can get you the 1% start rate is to take a 3yr pre-pay penalty. That means my fees are only $5000 which is less that what most people are charging". The bwr will agree...but not know they are getting $15,000 on the back from the broker by sticking them with the fat 3yr pre-pay penalty.
Can you believe that people end up paying over $20,000 to refi their house?!?!??! That is more than most people make in 3-4 months....and some "kid" working a phone made it in less than 30 days by putting in a few hours work. (yes, I know...not all brokers are kids, and not all brokers treat their bwrs with such disdain...but believe me, it happens more than you might think.)
I am starting to see things like this on credit reports (strictly an example that I saw): loan amount: $325,000 loan balance: $331,283 minimum payment: $982
So what that means is that the balance of the loan is higher than the loan amount...hence the term NEG-AM (negative amortization), and you see why...the $982 payment on $325,000. That "savings" has to go somewhere....and that somewhere is the back of your loan!
WHEW!! I hope that helps some. Again, not intended to be the most indepth overview out there...but should be enough to get the point across.
I do want to say that I do not know of a lender that will do an Option ARM to 100%. Most will do them for a max of 70-80% LTV, with 2nds or HELOC's behind them. These loans have their place for informed bwrs who are AWARE of the risks, and understand how they work. There are a lot of brokers that hate the loan even though it pays well. There are lots of brokers that DO disclose the "negative amortization" or "deferred interest" aspect of the loan...and make sure their bwrs know how risky the loan can be...and how payments can change. The reason I'm doing this blog...is so that people can be INFORMED and make the right decision for themselves. If they have to learn from the "pain" of others, or I have to point out the "misleading" ways things are sold, then I will do that. I sleep well at night...
Leave comments or send me e-mail. (socalmtgguy@gmail.com)
posted by SoCalMtgGuy at 3:25 PM
27 Comments:
hey im in the b/c biz now,
i was in banking on the east coast, now im in reporting, pricing, and analysis for a mort. co here on the west coast.
we do some a paper but mostly b/cs
i'd say 8 out of 10 are cash outs,
1 out of 10 are purch. 80/20s and 1 out of 10 are rate & term (no cash out). do you see the same pattern socalmortguy?
heres a fb:
85% ltv, 46% di, 540 fico, 30 yr i/o off a 6 mth libor, hmmm...
so if rates continue to go up he'll be at 55%+ d/i in about a yr yr and a half, if prices STAY THE SAME (they dont have to go down)
this is gonna get messy in '06
I agree with you completely about that FB.
Yes, I'm seeing alot of cash out refi's...and the 100% purchase. The problem I'm seeing now is appraisals NOT coming in where bwrs "think" they should be...as well as they can't afford their payments now...and want to refi to lower their payments (not happening).
We had a good 30yr fixed there for a while (few months ago), so I was "telling" brokers to find the bwrs that are NOT refi-junkies to get into 30 yr fixed.
Yes, it is going to get messey in 06 and 07.
remmember 12% of the mtg market starts to adjust in 2007. over 1 trillion in loans starts adjusting. That means those teaser I/O periods end...and the bwrs have to refi, or start paying principle.
watch out BELOW!
good site, socalmtgguy.
Who the hell is holding the bag on all these crazy loans? Someone besides the borrower is going to get f*cked big time. Fannie and Freddie on the "conforming" stuff (assuming the taxpayers don't bail them out), but who is buying the rest of this crazy shit and why???
Also, I saw a post on Ben's site a while back that said that banks have to guarantee the payments on loans they sell to Fannie, just like Fannie guarantees it to the MBS buyer. Doesn't sound right. I always thought that once the bank sold the loan to a GSE they were done with it; hence the total abandonment of lending standards. What's the story?
Have most of the recent ARMs been 2/28 IO types? Or some variation on that? What type of teaser rates do folks get, and for how long?
Do I understand these loans correctly: the bwr only pays interest at a lower, teaser rate to start with, say the first couple of years, then the entire loan adjusts so that they have the new interest rate (say tied to libor+) PLUS the loan begins amortizing?
I kept wondering how all these folks could afford the sky high prices - I thought they must all have tons of equity from another house, or an inheritance.
warenter,
yes, a 2/28 I/O would be a fixed interest only payment for 2 years, then the rate adjusts with the index it is tied to (usually the 6-month LIBOR) and they have to start paying principle.
Most of these 2/28's were done at very high LTV's...usually 100%. They were sold to bowrs with logic like "you can come back in 2 years when you have more equity and refi into a lower rate". Yup...cause real estate only goes uP!!!
mtgguy - what are the most common margins that these formulas use to adjust? ie: libor + ?, 1 yr. cmt + ?, prime + ?, cofi + ?
same for traditional ARM's?
thanks
BTS-
dont want to speak for socal, but we use 6 mth LIBOR,
and cause most have a life of 2 to 2 and a half yrs, the 2 yr swap to deterime the market price when its sold,
warenter: These Option IO loans allow you to make four choices each month for a payment. One of them is called the minimum payment which is actually lower than the IO payment! This means the remaining balance is tacked onto the loan principal. This is one way how you incur negative amortization!
If borrowers are resorting to minimum payments, and we bet they are most of the time, they can't really afford the loan in the first place.
sorry guys...I'll finish the rest of my option arm topic in the next day or so...
I have a busy few days here before we head into the thanksgiving holiday.
Hey
What is a "inverted yield curve"? I think you talked about it in Ben's blog. Can you explain?
I added a link to your super blog on my blog.
bubblemeter.blogspot.com
A year ago, noting the run up in RE prices, my husband said he wondered why lenders didn't come up with some kind of loan product where the bank shares the gain in equity with the borrower. I guess the lenders came up with the next best thing - a product where the borrower has to refinance every couple years in order to be able to afford the payment.
OTOH, I guess the banks will end up "sharing in the equity", the negative equity that is, when folks default.
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azgolfer -
Check out Ben's blog today (11/16) topic: "Even With Slowdown, California Homes A 'Sacrifice'" someone posted an article that discusses the inverted yield curve, it will give you a start.
out at the peak said...
If borrowers are resorting to minimum payments, and we bet they are most of the time, they can't really afford the loan in the first place.
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Lets see, if you cannot even make the I/O payment, you can make a lower payment that will drive up your principle so your new interest payment will be even higher! What a mess.
breakthespeculators,
Most traditional ARMs use the LIBOR...there are a bunch for the Option arms...
pretty much the ones you named. The MTA was really popular, and now the COFI is popular
warenter...
One thing I forgot to add...bwrs are not allowed to qualify on the min payment.
most have to qualify off the I/O or the 30yr term. Which is not that big of a deal since a lot of option arms are STATED.
socalmgtguy
Great info on loans. I definately have a few questions that I will ask the loan officer when I do buy a house in a year or two. Why are you giving us this info? doesn't it effect your business?
azgolfer
I am a mortgage banker...better known as an AE or account executive. I deal ONLY with brokers...and not with borrowers.
as much as I would like to think a lot of people would heed my financial warnings...I know that a very very very small percentage of the people in the industry will ever see this blog.
Besides...I'm not telling anything that most people in the industry don't already know. I'm just letting the people outside the industry know some of what is going on.
azgolfer...
basically, the answer is no. I don't think my blog is going to change the industry or my paycheck for that matter.
I just hope it saves some good people from being ruined financially because they ran with the herd and chased the mania so that somebody could make a quick buck off of them.
Socalmtgguy:
A couple of questions about these FBs.
1) who is the bagholder? When the FB defaults, who is left holding the mortgage? Is it some bank, is it some low quality MBS, is it freddie or fannie?
2) For whoever is buying these mortgages, has there been an increase in their reluctance to tak e on more of these loans? That is, is there any sign of growth in the risk premium?
Great stuff here. I look forward to any responses you can offer.
VHB
Most of the "subprime" loans, option arms, and other creative products are NOT held by fannie/freddie.
Most are packaged and sold to investors in the form of MBS. (china and japan were buying a very large amount of these)...as were many hedge funds, etc. Hedgefundanalyst might be able to help some here. I know 'he' was talking about it a while back on Ben's blog.
What you are asking is the "trillion dollar question". I wish I knew how it would all pan out.
SOMEBODY lent the money to these bwrs and wants to get paid back. The banks are holding the good stuff...and some of the bad stuff they could not sell. So in those cases, the bank will "eat it".
I am by no means in expert on the in's and outs of Fannie/Freddie...but even with all of their accounting problems, it seems like they are buying the less risky "conforming" loan amount loans. These loans require 20% down, or you pay PMI (mortgage insurance). Yes, they still buy a lot of "low income" bwrs loans to help with housing, but those are not the 900k option arms and other crazy loans.
Regarding your second question, Yes, I am starting to see a LITTLE bit of tightening going on here. It seems the investors want a bit more return for the risk they are assuming....at least now that every property in SoCal isn't going up 10k a month (or anywhere for that matter).
I think there needs to be a big tightening up of STATED income. I think once the defaults start rolling in, and they see the crap that is out there...and what they were REALLY buying...there will be repercussions.
I hope this helps some.
Great answers. Really informative.
Thanks,
VHB
Gee, I would have thought that when most of us see that 1% headline we would assmume that the thing was a scam and stop reading. But then I'm not sending money orders to Canada to pay taxes on my prizemoney. (unlike coworkers nephew)
This comment has been removed by a blog administrator.
1) who is the bagholder? When the FB defaults, who is left holding the mortgage? Is it some bank, is it some low quality MBS, is it freddie or fannie?
China, Japan etc wants our economy strong so that we keep buying their stuff. If they stop buying mbs, rates go up, and the economy goes down.
They are smart and every day they are asking themselves how to we 'optimize' our position. When debt gets bad by their standards, they will stop buying mbs and s... hits the fan.
The question I have is
"How does China and Japan define bad debt?" Do they think Americans will pay them regardless of what happens?
Can someone post a key on the abbreviatons.
What is Libor, LTV, IO etc?
Interesting post
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