Option ARM Home Mortgage Loan Getting Ready to RESET?

If you know of someone struggling with their house payment and can not receive a loan modification that reduces the payment and loan amount to acceptable levels, call us about a Short Sale.

What Is an Option ARM?

It is an Adjustable Rate Mortgage Home Loan on which the interest rate adjusts monthly and the payment adjusts annually, with borrowers offered options on how large a payment they will make.  The options include interest-only, and a "minimum" payment that is usually less than the interest-only payment.  The minimum payment option results in a growing loan balance, termed "negative amortization".

How Will I Know an Option ARM When I See One?

Ask the loan provider if the rate adjusts monthly, and if negative amortization is allowed. If the answer to both questions is "yes", you almost certainly have one.  Their names are all over the lot and include "1 Month Option Arm", "12 MTA Pay Option ARM," "Pick a Payment Loan", "1-Month MTA", "Cash Flow Option Loan", and "Pay Option ARM".

What Are the Advantages of an Option ARM?

Their main selling point is the low minimum payment in year 1.  It is calculated at the interest rate in month 1, which can be as low as 1%, and it rises by only 7.5 % a year for some years.

The low initial payment entices some borrowers into buying more costly houses than would have otherwise, or into using the monthly payment savings for other purposes, including investment.  You don’t need a list from me of ways to use the cash flow savings because your loan provider is sure to oblige.  What they are less likely to give you is a sense of the risks you will face down the road.

What’s Are the Risks of an Option ARM?

For those electing the minimum payment option, the major risk is "payment shock" – a sudden and sharp increase in the payment for which they are not prepared.

The rule that the minimum payment can rise by no more than 7.5% a year has two exceptions.  The first is that every 5 or 10 years the payment must be "recast" to become fully-amortizing.  It is raised to the amount that will pay off the loan within the remaining term at the then current interest rate – regardless of how large an increase in payment is required.

The second exception is that the loan balance cannot exceed a negative amortization maximum, which can range from 110% to 125% of the original loan balance.  If the balance hits the negative amortization maximum, which can happen before 5 years have elapsed if interest rates have gone up, the payment is immediately raised to the fully amortizing level.

Either the recast provision or the negative amortization cap can result in serious payment shock.

Many Jumbo loans are getting ready to reset for 100's of thousands of home owners.  Many can barely afford the loan now or are just making the minimum payment and realizing negative equity on original loan and appraised value at time of funding.

Coupled with lower prices and banks lending based solely on affordability it presents a combination of concerns.

Home owners ask if they should do a loan modification or a short sale?  Or will all this settle out and prices come back?  Will the banks refi my loan at current value and reduce the principal? (they are struggling to do this with much smaller sub-prime loans, hence the foreclosure rate skyrocketing) Should I refinance and still be considered "underwater"

These are the $64,000 dollar questions.. er, actually many hundreds of thousands of dollar questions...

One simple question needs to be asked, "Will everybody's income rise faster than taxes and everyday expenses like oil, food and etc. to help drive home prices up..?"

With this in mind we want to share a report that was handed out to our office in the beginning of April when unemployment was 8.5%.

We recommend reading this while sitting down - Click to View

Jumbo Home Mortgage Loan Modification