You Have the "Option" to Spend as Much as You Wish

When my manual "Let your Mortgage Make You Rich!" first came out, a dear friend who wasn't sure she could use the information offered to pay me to explain it to her. We settled on her buying us lunch at the Hilton Resort in Sedona. She brought mortgage statements for three properties she owned and asked me how she could save money on them.

I turned over the first statement and scanned the explanations on the back. Mind you, I'd never been good at reading financial reports, analyzing stocks or anything with math and fine print involved! But as I've indicated on numerous radio talk shows, the beginning of developing financial literacy is simply passing one's eyes (and brain, if possible) over the words in the contract - rinse and repeat - until they begin to make sense to you!

That was my first in-depth exposure to what turns out to be NOT a mortgage with lots of choices that help you, but a home loan payment plan with the possibility of being deeper in debt each and every month. Can we all say "YIKES"?

Here's how they work. You basically have three (or more) payment "options" each month:

1. payment the normal principal and interest
2. pay interest-only–keeping the house but never owning it
3. pay a "minimum payment" - much like a credit card minimum that doesn't even cover the interest for that month

The Upside of Option ARMs

The upside is, if your rich great-uncle's estate is about to clear probate in a few months, you can get into the home of your dreams right now, and pay the piper later when your mega-inheritance comes through - or other cash windfalls.

The Downside of Option ARMs

The downside is you owe more each and every month your name is on the loan documents for the home - if you choose the option of making only the minimum payment, an amount lower than the month's interest.

Here are some remarks from today's news and my comments on them… The first paragraph is for context, and basically could be replaced with blah, blah, blah… if you don't appreciate context. 

New worry: Option ARMs
A fundamental difference among the predictions [of the size of the mortgage collapse] is how people view the impact of foreclosures from impending payment increases. Investment groups, such as Credit Suisse, expect billions of dollars of mortgages to reset next year, meaning borrowers with adjustable interest rates will see those rates, and their mortgage payments, increase.

Those rate resets have analysts like Bellante especially worried about option adjustable rate mortgages because their resets can often double the minimum payment.

The loans, known as option ARMs, grow in value over time if the borrower pays the minimum. The mortgages reset once they hit a certain level, usually at 10 or 15 percent more than the original balance. The reset forces the borrower to cover all the interest and begin paying down the loan.

OK, so now this is getting serious. Your payment can double. Your rate will increase if your "deferred" payments due and original loan amount comprise 10%-15% of the original balance. So a $100,000 option ARM, on which you pay $300 a month ($200 less than the interest-only payment - principal and interest would be twice that!), could require you to pay $600 a month, yet still not addressing principal if the original loan plus deferred interest payments reach $110,000.

"The difference between subprime defaults and the ones we'll see from option ARMs is like the difference between walking out and having a kid on a skateboard hit you and walking out and having a Mack Truck hit you," Bellante said.

Did I say serious? People who took out these loans were looking to get into homes or investment properties really cheap, assuming property values would continue to rise and would overwhelm the amount they owed, so they could hold for 1-3 years and sell at a huge margin. BUT, what goes up cannot go up forever!!!!! 

Not only did prices not keep going up, these conspiratorious actions further devalued properties:

Economists say an increase of defaults and resulting foreclosures traditionally depresses prices because the banks that own the properties try to sell as quickly as possible.

…The National Association of Realtors is not as worried about option ARM resets, said Walter Molony, spokesman for the association…They expect total foreclosures, including those from option ARM resets, to hit 200,000 nationally. That is not enough to significantly affect prices, he said.

Oh really? Would you do it all over again?