Option ARM - The World's Most Dangerous Mortgage

Home prices have reached record levels, and in many parts of the country, homes have become nearly unaffordable.Real estate has replaced the tech stocks of the late 1990's as the hot investment, and everyone has sold their stocks and jumped into investment property.Real estate prices have increased at a far greater rate than salaries, and the lending industry has attempted to solve this problem by introducing a tremendous number of mortgage options for borrowers who barely capable of purchasing a home.Most of these loan types feature adjustable interest rates and minimum down payments. One of these, the option ARM, is the most dangerous type of loan ever introduced.Borrowers who are considering an option ARM should be aware that this loan could leave them with a loan that is worth far more than the home it's used to buy and with a loan that he or she cannot afford to pay.The option ARM is not for the squeamish.

So what, exactly, is an option ARM?An option ARM is a mortgage with an adjustable interest rate that typically gives the borrower four different payment choices each month. The first choice is based on a 30-year amortization table; the second on a 15-year amortization table.These would correspond to payments for adjustable-rate 30 and 15 year mortgages, respectively.The third choice is an interest-only payment, which pays the interest that accrues during the month but pays nothing towards reducing the loan amount.The fourth choice, the one that makes this loan so dangerous, is called the "minimum payment."The minimum payment is calculated upon the first month's interest rate, which is usually a very low "teaser" rate that can be as low as 1-2%.Most borrowers with an option ARM opt to pay the minimum payment each month, and that's where the trouble comes in.

The loan carries and adjustable interest rate, and this rate can adjust as often as every month.If the borrower is paying only the minimum payment, then he or she isn't even paying enough to cover that month's interest on the loan.What happens then?The unpaid interest that has accrued is added to the loan principal.The principal can actually grow larger, and as interest due is calculated on the loan principal, the interest due will increase, as well.Interest rates are currently near all-time lows and are sure to increase.A buyer who continues to make minimum payments on an option ARM will find that the principal on the loan is actually increasing over time!This is known as negative amortization.

In a negative amortization situation, only bad things can happen.The lender can require refinancing under certain conditions stated in the loan agreement.The buyer may find himself unable to pay the loan and may have to default.And the lender could find himself holding a note that is worth far more than the house that it represents.

The option ARM is a loan that is best suited to investors and homeowners who only intend to keep the home for a short time.It is not a good choice for anyone who may be using it to buy more home than he or she can afford.Unfortunately, that describes a lot of buyers who are taking out this type of loan.Anyone who is considering a home purchase should be very careful if this type of loan is offered, as it could leave you both bankrupt and homeless.

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Has Your Adjustable Rate Mortgage Become a Gamble?

Three or four years ago, interest rates on home loans dropped to levels not seen since the 1960's.  Millions of Americans took advantage of the favorable rates, which bottomed out near 5% for fixed rate, 30-year loans.  For adjustable rate mortgages, they rates were even lower.  Many buyers passed on the opportunity to lock in at fixed rates and gambled on the lower payments afforded by adjustable rate loans in order to buy either larger or more expensive homes.  That worked out fine at the time, as the rates kept the monthly payments affordable.  Unfortunately, the sixteen increases in the Federal interest rates since 2004 are about to have a dramatic effect on those buyers, many of whom many find out that they can no longer afford to pay for the homes in which they live.

Many adjustable rate loans are set up in such a way that the interest rate is fixed for the first three years of the loan's repayment schedule.  After that, the interest rate adjusts regularly, based upon prevailing market rates.  For the millions of homeowners who gambled and took out these loans in 2003, the Big Adjustment is going to come soon, and it isn't going to be pretty.  As the rates adjust to current rates from the low rates of 2003, many homeowners are going to be shocked to see that their monthly payments rise by as much as 50%.  Some will be fine with that, having anticipated this increase for some time.  Others will suddenly find themselves unable to pay for a house that they have long thought they could afford.  This will undoubtedly lead to an increase in the foreclosure rate, which is already some 60% above the rate of last year.  In Michigan, the rate is up by 90% over last year, as hundreds of owners have walked away from their home loans.

What can you do if you have an adjustable rate loan that is about to become unaffordable and may yet become even more so?  Your best bet may be to refinance and take out a 15 or 30-year, fixed-rate loan.  The benefit of doing so is the security that comes with knowing that your payment will remain stable over a long period of time, no matter what happens to the interest rates in the marketplace.  If you cannot afford your loan now and refinancing with a fixed-rate loan will still leave the payments unaffordable, you may have no choice but to sell the property and move to something smaller and/or less expensive.  You will not be alone.

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