by Bruce Hunter
Nearly a year ago then Chairman of the Federal Reserve Alan Greenspan warned of the "potential for individual disaster" from newer more flexible mortgages. Although he was referring specifically to "interest only" and "pay option ARMs," which are often conflated, he was concerned that consumers were not being made to understand the true nature of these mortgage products. Toward the end of this past September Federal regulators finally began to address this issue. I am of the opinion that Federal regulators are far too late on this one. They might as well be rearranging the deck-chairs on the Titanic and any regulation that comes will be cold-comfort for many a homeowner as the housing market continues to cool around the country.
I personally do not think that "interest only" ARMs presented nearly as much risk to the consumer as the "pay option ARMs" did and have been of the opinion for some time that this product borders on criminal. Before I delve too much deeper, I'd like to step back and explain specifically how the product works. A typical Option ARM, as we call them in the industry, has up to four payment "options" every month, a minimum payment, an "interest only" payment, a 30-year amortized payment, and a 15-year amortized payment. The last three payment options listed above are calculated based upon a typical ARM structure that being a margin over a specific market index, e.g. "monthly treasury average" plus 2.25%. It is the first option that is the most deceptive since it does not cover the actual amount of interest due what is referred to as negative amortization and I don't think that most people understand this.
My issue with these mortgages is not so much about how they work. It is really about the way they were marketed. Most of these mortgages were marketed by brokers and wholesalers as a way to get into an otherwise unattainable home by keeping the initial payments artificially low. You could not pick up the paper or listen to the radio for a long time without some broker shilling the "1% mortgage." They conveniently left out the part where the 1% does not cover the true interest of the loan and your monthly payment actually increases the amount owed on the loan at the end of the month. For this reason alone I argued in CORE over a year ago that most homeowners should avoid these mortgages, because the risks are far greater than they understand. As delinquencies and foreclosures increase around the country we are just now seeing the tip of this iceberg. Those markets that saw the most speculation are about to take it really hard. Studies have shown that a large number of borrowers with simple ARMs don't understand the terms and underestimate the amount their mortgage payment could increase; nontraditional ARMs are even more complex. By now, it should be evident for nearly everyone that the housing market is coming to a screeching halt in the most overheated markets. Some economists have predicted price fall-offs of up to 15% in some regional markets which is why I feel Option ARMs are so dangerous. I'll illustrate this for the most overheated markets, starting by quoting myself from a CORE article I wrote about a year ago.
"Beware of the 1.00% mortgage. Trust the old saying, 'If it sounds too good to be true it probably is.' This holds just as true in mortgage lending as with anything else in life and I can guarantee you that there is no such thing as a one-percent 30-year fixed-rate mortgage. Furthermore, there is no such thing as a one-percent six-month, one-year, three-year, five-year, or seven-year adjustable rate mortgage or ARM either. So you are asking yourself, 'What was that ad I saw in Sunday's paper talking about then?' The answer is simple; it is an option-ARM and they are great loans for the right type of borrower. (I have since changed my mind on this; I don't think there is a right type of borrower for this product. Too many people use only the minimum payment option. As many as seven out of ten borrowers with these loans use only the minimum payment according to UBS.) They typically allow you the flexibility to make one of four types of payments, a 30-year or 15-year amortized payment, an interest-only payment, or lastly a negatively-amortizing payment. It is the last of these payment options that have the potential to be dangerous if the borrower does not understand how they work and this is the 1.00% that is advertised. So what is the truth, it is a great payment is it not? Yes, it is for a short time, but you are not really getting a 1.00% mortgage. What you are actually getting is a rate based on an index such as the cost of funds index plus a margin and the 1.00% payment you are making is only a portion of the actual interest due, the difference (negative-amortization) is added to the principal balance of the loan thereby increasing the amount you owe. For example, say you have a $200,000 mortgage and your current fully-indexed or actual interest rate is 6.972% the payment should be $1326.00 per month. If you made the 1.00% negative-amortization payment for the same loan of $643.00, the $683.00 shortfall ($1326.00 - $643.00 = $683.00) is added to the principal balance. So after you have made your payment you now owe $200,683 instead of $200,000. What you owe is actually going up not down. Compound that over several months or years and soon you have added thousands of dollars to your mortgage."
Okay, so if the said example above was based on a mortgage of 95% of the value of the home and you're in a market that is seeing any kind of downturn, guess what? You're upside-down on your home very quickly since the unpaid interest is added back to principal. Once principal exceeds 110 percent or 115 percent of the original loan, the minimum-payment option goes away. Borrowers are then faced with a payment double or triple the minimum. The really brutal thing about these mortgages is that most come with a "soft" pre-payment penalty of some sort, meaning they cannot be refinanced without a hefty penalty of some sort, usually two or three percent of the loan amount. And some loans even have what we in the industry refer to as a "hard" pre-payment penalty, meaning you cannot even sell the property without a heft pre-payment penalty. So again, just to hammer home the point, you have a great many homeowners that are already upside-down on the mortgage, the mortgage adjusts upward and they can't afford to refinance or sell because they would have to bring money to closing and they can't afford to make the payment. Although the Denver market did not see that a great many of this type of mortgage I have still spoken with many a prospect lately that was in one and could not refinance out of it. Oh, and did I mention these loans are heavy commission loaded?
So what options do you have as a homeowner if you have one of these loans? The best thing is to make sure you are making more than the minimum payment. If you are not, begin to as soon as you can, preferably the 30-year amortized payment listed on the monthly statement. It might be a stretch at first, but it will begin to nibble away at the principle balance of the loan and put you into a better position if you need to refinance. If it is too much of a stretch to make the 30-year amortized payments try to make at least the interest only payment. If all else fails it might be worth speaking to a mortgage professional about refinancing into something fixed. In many cases actual 30-year fixed rates may be lower than the rate referenced on your monthly statement.
http://www.core-media.org/content/view/303/369/
Subscribe to:
Post Comments (Atom)
No comments:
Post a Comment