Across America there are a record number of loan defaults and foreclosures and some blame, in part, a loan program called the Option Arm. The truth of it is these can be great tools for mortgage professionals to use with the right clients or they can be complete nightmares for others.

Option Arm’s give borrower’s great flexibility in payments, which can be very useful for those borrowers that have fluctuating incomes. Those borrowers that work on commission, receive a large portion of income as bonuses or those that are starting new in their business where a substantial change in income will come down the road. On the other hand, for those borrowers that utilize an Option Arm loan to afford the home purchase is setting themselves up for disaster.

It is critical that you work with a knowledgeable Certified Mortgage Planner that knows the ins and outs and explains in great detail how the Option Arm works. In 2000 there were only two or at most three lenders that offered these types of loans. As their popularity grew among borrowers by 2003 nearly every single lender in the U.S. had some form of Option Arm product.

All Option Arms are not created equal. They each have differences and depending on the borrower these differences can be catastrophic. At the very least you should to have a basic understanding of adjustable loans and how they work. This means at a minimum, you should already know what margin and what index mean in the context of any arm loan before looking into this loan product.

Part of the mystification of Option Arms is the many “working parts” and how they integrate into the loan. It’s very important that the loan officer know each and every detail and can explain each part so the borrower can make the most informed decision. This will vary greatly lender to lender. At a very minimum some are:

• Margin
• Index
• Minimum Payment
• Fully Indexed Payment
• Deferred Interest
• Recast Point                            
• Payment Caps
• Interest Rate Caps
• Pre Payment Penalty

The biggest error a borrower can make when getting an Option Arm would be when the pre-payment penalty is longer than the recast point. This can be detrimental to the borrower and cost tens of thousands or worse put the wrong borrower in foreclosure.

The loan officer should be able to provide a detailed analysis of your yearly payments, when exactly the loan will recast and how much deferred interest you may accumulate. Get an amortization schedule. If they can not provide these items do not take out the loan or find a knowledgeable one that can.

The bottom line is this is a great tool in the right hands, provided by a knowledgeable loan officer, to build wealth for borrowers and used to achieve your financial goals.

I received a call Friday January 25th, 2008 from a freelance reporter in Los Angeles named Marcie Geffner who was doing a story for a well known bank website called BankRate. She wanted to interview me to get my opinion on whether those with adjustable rates should take advantage of the lower fixed rates and refinance.

This interview led me to some important points that I want to make. It’s not a marketing secret that scaring the crap out of consumers is a pretty useful sales tactic. People buy on emotion and make emotional decisions and the news media and advertisers sell products that way.

 I have been pounding the table since May 2006 that the Federal Reserve would start to lower rates in the fall of 2007; you can see my Blog post at www.bbmteam.com and look for topics under May 2007. So this big whoop la comes as no surprise.

What needs to be understood is that mortgages just like any investment should be managed. Just like investments, different loan products “perform” better during certain periods and working with a certified mortgage planner allows customers to take advantage of changes in market sentiment and conditions and save $10’s of thousands of dollars.

Managing a mortgage is not about getting the lowest interest rate. It’s about matching the mortgage to the client’s financial goals. When you match the mortgage to their financial goals rates do not matter. The loan program that you have is meeting a certain financial need of the borrower.

This is part of wealth creation I explain to clients. In this business I have meet many people who have achieved great wealth by aligning their mortgage (s) to their financial need. I have never met one that achieved great wealth because they received the lowest mortgage rate.

It’s my job as a Certified Mortgage Professional to help borrowers make smart choices in selecting or maintaining a home loan. So to answer her question, should a homeowner with an adjustable rate refinance to a fixed rate? In a broad and general sense, absolutely not! Many people are going to be enticed to refinance into long term fixed rates. If the only reason someone is refinancing is to secure a “lower rate”, then save your money.

Let’s take a look at just two popular adjustable loan programs and important points.

MTA Indexed Loans (Option Arms)
The MTA Index is a lagging index, meaning it takes a snapshot of the last 12 months of the CMT or Constant Maturity Treasury. Right now the MTA index is at 4.522% down from 5.0142% in February 2007. More importantly, the CMT, is at 2.19%. So over the next 12 months those with MTA loans could have a rate based on 2.19%, a full 2.33% lower than the current 4.522%.

1- Month LIBOR Indexed Loans
For those with U.S. denominated 1MO LIBOR (London Interbank Offered Rate) loans another popular index for an adjustable loan, is currently trading at 3.285% down from 5.3% last January, over 2% less.

**Every index is different and will not perform the same. There are no fewer than TEN different indices for adjustable loans.

So it would not be in the best interest of anyone refinancing just for rate. If you were refinancing for a life goal i.e. college or retirement planning, then that’s a whole different topic. There is so much money wasted with consumers refinancing just to reduce their rate and 80% of the time they are ADDING years to their mortgage. So what is the real savings? Do you add 3, 5 or more years to save a couple hundred dollars? No advice, bad advice and D.I.Y.’s loose 10’s of thousands maybe even hundreds of thousands. It’s really a shame some consumers do not spend more time investigating mortgage professionals based on advice.

Alan Greenspan has taken a lot if criticism recently for a statement he made recommending homeowners back in 2004, that they should have adjustable rate mortgages. Greenspan stated “the certainty of fixed-rate mortgages may not be worth cost. In a rare evaluation of the interest rate options that households face, he questioned whether American homeowners are well-served by popular fixed-rate mortgages.”

His point can be best explained this way. I have a chart that I show most all my clients. This chart shows the last 210 years, yes 210 years, back to 1790, of Treasury Bonds and what this chart shows is that for 185 of the last 210 years, mortgage rates have been below 7.5%. I can not publish the chart here for copy write reasons.

If you look at the chart of interest rates since the Reaganomics era, rates are on a decisive and consistent downtrend. After a high of 17.5% in January 1982, they went all the way down to the 7% range by the year 1990. Interest rates consolidated in the 7%-8% range till the year 2000. Between the years, 2000 - 2005 they resumed the downtrend to a low of 4.5% - 5%. From 2005 – 2007 they went up to 6.5% and again in 2008 resuming the down trend again.

We were refinancing loans at 4.5% and borrowers telling us rates will never be this low again. How misinformed!

So at what point between the Reagan era and today would a consumer have been best served in a 30 year fixed rate loan? Never. You would ALWAYS have been better in an adjustable rate loan, for the last 25 years. Even if you had an adjustable during the Reagan years and paying 14% -16%, rates are relative. Whatever mortgage rate you pay, is pretty easy to receive in other interest bearing accounts, meaning you were receiving 14% - 16% in pretty conservative savings accounts, certificates of deposit etc. Look how easy it is to get a 5% guaranteed rate today.

You have to understand The Why behind the high rates of the 1980’s. Once you understand The Why, it can be said with pretty good certainty that we will not see double digit interest rates again. Our economy, monetary policy and foreign policy are vastly different than back in the Carter – Reagan years.

© 2008 Benjamin Borden

About the Author: Benjamin Borden, a Certified Mortgage Planner, is one of the top mortgage professionals in the State of Virginia. Ben has been helping customers for over 15 years integrate the mortgage they select into their overall financial plan, advising clients on wealth creation, retirement, debt consolidation and college funding. For more information on Ben please visit his mortgage planning website and his mortgage advice blog.

 

In an emergency phone meeting, Monday night, the Fed Cut Rates .75%. The biggest one time rate cut since 1984. The Fed meet before its scheduled January 29th-30th meeting and is expected to cut again at that time. This move all but says we may be in a recession.

The stock market is scheduled to open with its worse drop in recent memory and bad news for Bank of America, reporting it a 95% drop in net income and may call in to question the buy out of beleaguered Countrywide.

If Bank of America does not go forward with the Countrywide buy, Countrywide is all but assured a spot in Federal Bankruptcy court and that would send additional shock waves through the financial markets.

Those with adjustable rates gotta be loving the current rate environment. Those with a home equity line of credit will see their rate decline this month of at least .75%. All the short term adjustable rate indices’s, such as the LIBOR, MTA and CMT will have huge declines today and over the coming months so we will all see our payments going down.