Option Payment Mortgages

A loan product to be aware of when shopping for mortgages is the payment option mortgage. It is a program which offers four monthly payment options. You are able to make a minimum payment, interest only payment, thirty year fixed payment or a fifteen year fixed payment each month. The product is usually offered with a one month promotional rate and is subject to adjustment every month. The product is based on what is referred to as a “fully indexed rate” or FIR. In my experience the product has always been priced using the MTA index (which can be monitored in most financial publications). This index plus the margin (determined by you and your lender) determines the fully indexed rate. Therefore, if the MTA index is 4.25 and your margin is 2.25 your fully indexed rate would be 6.5. So, the product is a monthly ARM (adjustable rate mortgage) the index is subject to change monthly while your margin remains the same. The real danger in this product is found in the minimum monthly payment option. This payment is less than the interest only payment. If a borrower doesn’t pay enough to cover the interest on the loan the interest is “deferred”. This term suggests the interest can be payed at a later date and it can. However, if it is not payed at a later date it will be added to the principal balance of the loan. When a borrower continues to defer interest negative amortization occurs. Negative amortization is the process of using principal in the house to cover the interest cost not included in minimum mortgage payment. State law limits the loan to value percentage a borrower can reach before the loan is “recast”. Most states will allow a borrower to reach 110% of the home value before the bank restructures the loan. I said earlier deferred interest can be payed at a later date. This product can truly be beneficial to those who can properly use it. If a borrower is paid primarily through lump sum commissions, is self employed, or receives most of his/her income through annual bonus this product can be a lifesaver as the deferred interest can be payed when the funds are available. This product can also be beneficial for real estate investors. First, an investor can purchase a home in a growing neighborhood using this product, make repairs and season the title on home, then sell the home covering the differed interest through the appreciation of the home. Or the investor can buy a home using this product and rent the property covering payments through rent income. Why use this product if you are an investor with renters you say? As the monthly payment on this monthly adjustable mortgage can increase, in a declining rate environment the payment can decrease as the index declines. This means income for investors. Considering the default rate in today’s market, the number of lenders (especially sub-prime) going bankrupt and the housing inventory we are currently experiencing it is important to be aware of this product. The start rate can be as low as 1.25. A borrower could borrow near $1,000,000.00 for close to $3000.00 per month based on the minimum payment option. The second month the payment could be close to $8000.00. Therefore, it is important to see beyond that low monthly payment on the paper in front of you and understand the nuts and bolts of what is really being offered.