Home : Blogs : SHAUN WREN : SHAUN's Blog

Option Arms Will Be Next.

With all of the hype going on about the Adjustable Rate Mortgages, I guess the next thing is going to be the Option Arms. I have to agree that there a lot of people getting these loans that have NObusiness getting them. On option arm allows you to pay a teaser payment. Usually 1-2.75% wow. that sounds like a deal. But what some brokers are not stressing and should is that your combined interest rate is going to be higher than a conventional loan. Although your payment is very low ,you are still responsible for the rest of the interest. You just don't have to pay it with your payment. The rest of the interest comes out of your equity.

I am not trying to read the future. But I can see the headlines already. He didn't tell me that My amortization was running negative. "I just wanted to live in a nice home like my friends."

Give me a break. If you are doing an option arm and payiny 1/2 of the payment that you neighbor is, Something is wrong.

Posted by SHAUN WREN on 07/05/2007 12:19 PM

Comments (15)

option arm

15 Comments on Option Arms Will Be Next.

JUL

2007

Shaun,

I agree that many are selling the loan to the wrong client. People typically get too caught up in "the rate" or "the payment" without really looking at the details. I am sure many will come back and blame the LO for not disclosing the truth. Fact is over 1/3 of consumers are clueless about the type of mortgage they currenlty have. I explain the programs in detail to my clients but many don't remember the details. The biggest thing we are seeing now is customers being surprised by the large pre-pay penalties. I don't know how much it is the fault of Loan Officers not explaining the details, the attorneys not covering the facts at closing or the consumer not remembering the facts. They wanted that lower rate and the LO used pre-pay penalties as the bait.

Is there a model where the Option Arm makes sense? Absolutely! In our seasonal vacation market, it is a great tool to manage cash flow. Is it the best product for most first time home buyers - absolutely not.

I couldn't agree with you more. I ask the customer how long they plan to be in the property. Then I let them know what the rate would be with a pre-pay and disclose the cost of the prepay to get out of it. I normally don't do a prepay because you never know. Their situation may change and the home they have may not be right for them any more.

Agreed and if the State of Colorado out laws NO DOCS and NINA's I bet they get around to these loans also

Also, don't forget the borrower has to pay interest on the deferred interest! Thats why the banks love these loans! Also, every loan officer on this site knows the real reason why people got jammed into these loans.

I have done two of these loans; both to investors against my recommendations with only 1 year hard Pre-Pays on them. This is a scary loan!

rEY- aS YOU WELL KNOW . It has to make sense.

I agree with the necessity to FULLY disclose these loans. I have done only 2 in the past four yrs. I have had many people ask about the loan with the low interest rate, and once I explain how it works and that I don't reccommend it for the "typical" consumer, they chnage their mind about it. I also agree that far too many Lo's put people in these loans because of the money to be made.- Disgusting-

On the other hand this loan does make sense for the right client. It's not a scary loan unless it is placed in the wrong hands by the wrong originator. There are a few companies I know of out there that still heavily promote this product and this product only to build greater wealth. While it certainly is a loan that can be used in that capacity, it is not the ONLY loan one could use. I would steer clear of any originator who seems to want to sell this product more than any other loan option available.

As Shaun stated above- "It has to make sense" and I'll add, "for the borrower, not the originator"

Thanks Micki.

Out here they are investigating alot of loan officers that would only place people in Option Arms with 3 year Hard Pre-Payment Penalties. There will be some fines on those comanies!

Doesn't anyone remember the 80's? Bad hair, worse clothes, and oh yeah, the S&L scandal. Every generation has to have one.

The 90's it was cooking the books flying fast & loose, the wheels fell off that apple cart in 200 & 2001, can anyone say Enron? How about MCI. Anyone remember TYCO (not the toy company).

I am not quite 40 - but the truth is, this is all I have ever done! I have only been a lender my entire career! The latest scandal I think is on the horizon, and that is the Sub Prime scandal and it will be epic proportions. Every homeowner in America will pay the price. Sadly, this will overshadow the Neg-AM scandal. No one in these postings seems to recall this isn't the first time we have seen NEG-AM loans. They were very popular in the early 80's when rates were double digit!

Every American will pay the price will be paid in higher rates and lower property values (i.e.; declining values). Personally; I have sold 1/2 dozen of them, and made a ton of money when I did! Each loan was in excess of 1MM, each one had a 3yr Hard PP (Michigan caps them to 1%) and I charged a full point so I made an average of 3.5% on each of them. HOWEVER; these were very sophisticated borrowers and I FULLY disclosed to them, including an additional NEG-AM Disclosure my bank required.

What ever happened to the old adage" Never sign a document you haven't completely read & understand?" I remember being taught that in the first grade!

Bank with someone you know, drop by or give me a call today.....Ricardo Cobos Your LOCAL Traverse City, Michigan Mortgage Lender

I agree with those who advocate the appropriate product for each client and for ensuring that the client truly understands the pros and cons of the product. I generally re-review the features of the product when I do my quarterly loan checks with my clients to help reinforce what they originally learned.

However, not all option arms are equal. There are option arms and then there are option arms. When we select the right option arm and are able to stay the course through a full home appreciation cycle of 5 to 8 years there can be tremendous value. What do I mean by "right" option arm? First of all it has to have a recast term which is long enough to provide some degree of protection which is combined with a high enough LTV allowance. Secondly, choosing the appropriate Index for the borrower's risk tolerance will also play a key role. The product that meets this criteria provides 125% LTV with a 10-year recast and either the more stable COSI, CODI or COFI indices. It is also very important to show clients how to use the cash flow in ways that will help them improve their financial health (i.e. funding a 401k and taking advantage of a company's matching program, paying off higher interest debt, making prudent investments, etc.).

So for example, knowing that the national average for home appreciation is 5.65%, let's a assume a modest (for CA) 3% appreciation y-o-y for a home purchased at $531,250 and financed at $425,000 with this pay option using the COSI index at 7.07% with a 1.00% start rate and only the minimum payment made for 6 years. Let's see what this might look like if we assumed that rate throughout the 6 years without the benefit of it lowering during that time frame (and by the way that would be almost its highest level based on the past 6 years of COSI rates).

Yr. 1 Min. Pmt: $1,367, I/O Pmt: $2,504, 30 Yr PI: $2,848, 15 Yr PI: $3,837

Yr. 6 Min. Pmt. $1,962

Total deferred interest = $ 61,464 + $425,000 (original loan) = $486,464 New loan balance

Appreciation (3% y-o-y) = $103,090 + $531,250 (original price) = $634,340 New home value

Equity at end of 6th year - $147,876 - $106,260 (initial equity) = $41,626 Increased equity despite deferred interest payments.

By making exclusively deferred interest payments in this scenario the borrower created an additional $86,195 of cash flow to be used for investments, or other financially healthy investments, yet was able to grow their equity in their home.

Obviously there are many factors that come into play that will impact this type of exotic financing (i.e. rates at the time of entry, terms of the program chosen, index, margin, etc.), not the least of which is how responsible and knowledgeable your borrower is; but educated and used appropriately, these types of products can be powerful cash flow and investment tools that be used to create tremendous arbitrage opportunities.

I also like the idea of the borrower who chooses not to make the minimum payment, but sees the product as a sort of personal mortgage insurance product so that in the event they should become disabled, unemployed or run into an unexpected cash flow problem, they have the options they would not have otherwise had with other types of products. Again, it comes down to the degree of self control the individual borrower feels they have.

I like to share the good and potentially harmful points of this type of product to my clients and find that many times they find it within themselves to decide what kind of borrower they are. Having said that, I don't present this type of option when I can see from a credit report that I'd be setting them up for disaster because of their past credit behaviors.

Just some food for thought.

Unethical behavior is everywhere...thanks for letting us know about this.........

I wonder why people come up with these loans and hornswaggle people into them......

GREED I guess, hmm?

=-/

JUL

2007

Helene- You have made a great point. This is an awesome loan program for an investor. But, in my area there are unethical lenders trying to sell this program to anyone that will take it because of the commissions and That My Friend is wrong. We are as professionals in a position to get the right loan for each person based on their circumstances. Not on how much the broker will make.

Alex-When judgement day comes. my portfolio will be fully disclosed.

Alexander I am amazed that you would use the word GREED to describe a lender and more importantly assume that someone has been "hornswaggled" whatever that is supposed to mean. An quick Internet search reveals the general consensus is the modern defenition is to "'to cheat or trick, bamboozle". This is not to say there aren't dishonest people in lending, but that can be said of real estate sales as well as ANY industry.

In my opinion, a good Realtor should be asking and advising clients on ALL aspects of their home purchase, acknowledged the sales price is only one component of the transaction. If they attended the closing, and in my experience I have only once seen a Realtor no-show at closing, after all, it is payday! Then they should be advising their clients that the mortgage lender they have chosen is attempting to "'cheat or trick, bamboozle" or otherwise hornswoggle" them.

I think we all know this isn't the case.

For years the American consumer has been loading up on consumer debt making minimum monthly payments, buy now pay never. Financing their cars for 5 and six, even seven years, putting no money down and then trading them in every three years and not understanding why they owe $5M more than it is worth when they drive off the lot ins a Kia with a $500 per month payment!

This is the type of behavior that led to the resurrection of the Negative Amortized mortgage aka Option Arms.The Key here is the borrowers has the OPTION of how he makes his payments, if that borrower exercises his/her OPTION to pay less than the fully amortized payment or at least the interest earned during that period, then that is his OPTION! When he/she exercises that option, it is no different than exercising any other OPTION, and all OPTION's have consequence.

The behavior pattern is typical, Americans want to buy now, pay never, and it really comes down to keeping up with the Jones and the number one and two reasons people buy;

Keeping up with Joneses
Greed

Is your home a piggy bank?

The American Savings Rate is Pathetic! Americans continue to use their single largest LONG TERM asset as a piggy bank. Every 3 - 5 years, tap the equity, pay off cars, credit cards, or perhaps deferred interest and everything is OK. Then they cant figure out why they have no equity when they sell their homes!

DISCLOSURE:

Retail mortgages are the most regulated and disclosed retail transaction that exists! You can give your stock broker 1MM to invest and not have the amount of disclosure required if you purchase a home for $35M! Any customer who makes it to closing without being FULLY DISCLOSED, has been in fact hornswoggled. This is rarely the case - the customer simply wants the house at the lowest monthly payment regardless of the consequence, who's fault is this ultimately? The lender who loaned to them (so the Real Estate commission could be earned?) or the borrower who borrowed?

Sober Up!

It is time for the American consumer to sober up and grow up - take responsibility for your choices and live with the consequence of those Choices. No one ever get's angry when someone makes a wise investment choice, they simply say they were lucky or times the market well. Forget the fact that they made good choices!

Bank with someone you know, drop by of give me a call today.....Ricardo Cobos Your LOCAL Traverse City, Michigan Mortgage Lender

For the record Shaun, when I offer this product to my clients there are no points, no rebates, my 40 bps (refi) 100 bps (purchase) are part of the 2.15 margin. I have seen Wholesalers who sell the product tend to gouge clients for this product, but when they come direct they get a pretty fair shake.

Providing a tool and the education on how to use the tool to help clients build financial health and wealth sort of goes hand-in-hand with fair, healthy pricing; at least that's how I run my business.

:-)

Helene- I am glad that you are fair with your customers. I hope that you didn't think that I though you were not. On my drive to work I normally see half a dozen snipe signs on the side of the road that say 1% financing call********. This is a bad practice and violates The Florida 494 rules. They are not disclosing apr. Unfortunatly even if they do ,unless you sit down and show the consumer how it will impact their equity, They still won't understand this program.

Leave a response…

Name:

Email:
(optional)

Comment:

What does the graphic say?