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!
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.
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...
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