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Pick a Pay - Understanding the Recast

Over the weekend my friend in Florida, Bryant Tutas posed a question about a particular loan product offered by his Wachovia Rep. It was called the "Pick - a- Pay".

Out here on the west coast we know the P-A-P well. It's nothing new. It has been a staple of World Savings for the longest time. What Bryant was asking about was just one version of the Pick-A-Pay, the "30 year fixed" variety. It's now being offered by Wachovia as they bought World Savings a couple of months ago.

What's a Pick a Pay?

Pick a Pay is the name brand that World Savings branded their Payment Option Arms with. All their Payment Option Loans are called titled with PAP. Pick a Pay is just the brand name. many of the lenders have fancy sounding names for their Option Loans. Quicken calls theirs the "Smart Choice", Countrywide has the "Payment Advantage", Bank of America calls theirs "ManyOptions". They are all just brand names.

In the broad sense all of these loans are Payment Option Loans. They all have a Negative Amortization feature. Is this good or bad you ask? They say the Devil is in the details. Let's look at what makes a Neg Am loan tick - shall we?

Ingredients

To properly understand any Neg Am Loan you must know what goes into it. Here's the minimum you'll need to know:

Note Rate - this is the actual interest rate you are paying on the loan. It might be adjustable, it might be fixed, it might be fixed for a portion of the time.
Teaser Rate - This is what determines the minimum payment.
Term is the life of the loan (30 yrs, 40 yrs, and so on)
Recast Period - This is the predetermining point in time that your loan will "re-balance" in order to payoff by the set term.
Recast Percentage - this is the line in the sand at which your loan cannot exceed. A typical recast percentage might be 110% to 125%.
Index - The Index comes into play with Adjustable rates. The Index is the adjustable portion of the ARM.
Margin - This is added to the Index to compute the interest rate. Index + Margin = Rate. Unlike the Index - your margin will never change. It is set out in the Note you signed.

Plugging in the Numbers

To illustrate how these all come together let's look at a hypothetical loan.

Please note: All rates are inaccurate and are used here just for illustration purposes. The rates are actually ones that a potential client came to me some time ago. When they last refinanced, an out of state loan officer sold them on this "bad loan". Unfortunately I couldn't help them and they eventually lost the house.

Loan Amount: $400,000
Note Rate: 8.33%
Teaser Rate: 1%
Term: 30 Years
Recast Period: 5 years
Recast Percentage - 115%
Index - 4%.
Margin - 4.33%

Given the above figures the borrower would have a monthly statement that has 4 options:

Minimum Payment: $1,287 (loan amount, using the teaser rate and amortized over the term)
Interest Only: $2,777 ( loan amount, using the note rate)
30 Yr Payoff: $3,028 (loan amount, note rate, amortized over term)
15 Yr payoff $3,899 (same as #3 but with a 15 year term)

Deferred Interest

If the borrower pays the minimum payment each month the difference between the Minimum Payment and the Interest Only are added to the loan balance. This is called Negative Amortization but since the lenders don't like words that sound bad, they'll call it Deferred Interest. In our illustration above, the borrower will add $1,490 this month to his loan balance in "Deferred Interest".

Bring on the Recast

Each month, if the borrower pays only the minimum due, the Deferred Interest will cause the balance of the loan to go up. If the loan balance goes above the line in the sand called the recast percentage the payment options start disappearing. (see the red line in the above chart) That's what happened to this Client. The loan was scheduled to Recast in 5 years or 115%, whichever comes first. It's the Recast Percentage that got them. It didn't get them in 5 years, it got them in month 39!

Here's an actual online calculator from a Lender showing what happened.

In Month 39 the lender took away the Minimum Payment, they took away the Interest Only payment and the borrow was forced to pay $4,096 a month. The month before they paid only $1,487 - this payment was almost triple. They couldn't pay and the home went into foreclosure.

Bad, Bad, Bad...

Looking at this scenario it's easy to how unethical loan officers could sell this loan product and send people down the road to financial ruin. The media has branded these loans as Evil. I've seen some honest loan officers who have tried to distance themselves from the negativity of this loan. "This loan is a bad loan. I would never allow any of my clients to use this loan". This is just wrong thinking.

The loan I illustrated above was definitely a "Bad Loan". It had a bad margin, a bad recast, bad caps, bad points and fees, and a bad prepayment penalty. It was sold by a bad loan officer who misrepresented the loan. It was a bad solution that did not fit the needs of the borrowers. It was bad from the start.

I'll make the point, and I'll stand up on my soapbox to do it. It isn't the loan product that is bad. This loan is (and was) sold to all the wrong people for all the wrong reasons by the wrong people. Given the right circumstances, with the right people, with the right terms, this loan is a wonderful loan! Any loan officer that flat out refuses to use this loan is working short sided.

A true Mortgage Planner knows what I am talking about. Learn the loan, know the loan. Apply the best product for the proper situation.

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Posted by Mike Mueller on 10/08/2007 01:55 PM

Comments (14)

neg am loans, payment option arms, wachovia, world savings

Originally posted at: Mike Mueller, Social Media.ist: Pick a Pay - Understanding the Recast

This post has been included in California Information

14 Comments on Pick a Pay - Understanding the Recast

OCT

2007

HHHHmmm, So I guess your stance is that this loan is "bad"? I disagree if it is used for the right reasons and the client is educated in how the loan works.

Sean Allen
The Mortgage Professionals

Sean - did you read the whole article?

"It isn't the loan product that is bad. This loan is (and was) sold to all the wrong people for all the wrong reasons by the wrong people. Given the right circumstances, with the right people, with the right terms, this loan is a wonderful loan! Any loan officer that flat out refuses to use this loan is working short sided."

I think that it can be a very dangerous loan program. Borrowers that are very disciplined could probably do well with this..However, I believe that for the most part, most borrowers are not going to survive this loan program.

Mike - Great Post!!

Lauren - Thanks! My point exactly. The program isn't for most people. It was sold to most people though. I've done three Option Loans in my 14 years - just three. All three were to contractor types who needed the additional capital available to apply to the rehab. They were in and out in a year or so.

I had an office next door to me that closed 20 a month. How many borrowers of theirs do you think knew what they were getting into? I'm guessing none. They're out of business now. So is the other office down the hall.

Mike M.

Awesome post, getting people to understand the loan. I can say that I've sold several of these in my career, but only to highly sophisticated investors, not to everyday consumers, unless of course they were at a 30-50% loan to value with a clear understanding of the premium they were paying for the loan.

I like your rising rate scenario format....would you be kind enough to email out?

Thanks Bill - Drop me an email and I'll attach it in the reply *.

* I created a .xls for the 30 yr fixed option loan and offered it to any who wanted it on Bryant's post. It's an .xls so you'll have to send me an email first (we can't attach files through the AR interface)

Well that's as clear as mud. I guess that's why I'm the REALTOR. I'll keep trusting my preferred mortgage professionals to explain this stuff.

Lisa - I just choked laughing at your comment! You keep reading, it'll start sinking in. (like mud)

Well, Mike, it is clear to me, and I think you did a wonderful job of explaining something that is tough to understand. Thanks....when I first started in the business it took me forever to figure out these loans....all the while I am saying, "wait, why would we do these??????" Meantime, every LO in the office had one of these on their own home!

Lisa- Good response !! That's why that one Mortgage Company that Mike mentioned was able to originate so many...Because for most people they don't understand the program and those Loan Officers took advantage of those borrowers.

Mike- You did a great job explaining it... It took me awhile to really understand it and how it impacted the borrower.... when I was a Loan Officer in my past life.

Mike - my brother is a financial planner. When I went to get a mortgage I asked him the best thing to do. He went into this huge shpiel about real vs projected income. After about 20 minutes I realized I had opened Pandora's box - I was like Dude, Arm or no arm, Points or no points? When all was said and done I was really glad to know the reasons behind all of the decisions I made, but I don't think most people know that much about it or have a family member that is an ex-Dead Head turned financial wizard. Having a trustworthy Mortgage agent is key.

OCT

2007

Mike,

I have always looked at this product for Short term owners, and Investors. These brokers who sold these products, completely ruined the whole point of this Loan!! that in it's self makes me furious, but for the ones that were done right, well those are happy clients because they know what they got as a Loan.

Wow!! I'm out of breath :0)

Tom Weiss

OCT

2007

Mike,

Thank you so much for taking the proper time to explain in detail the Option ARM Product. I have always looked at this product like a gun. A gun is not bad if used properly, by the right person and that person undestand the responsibility behind the weapon. But when a gun is abused, it can be deadly and dangerous. The same applies for the Option ARM product. I personally do not sell many of these loans, but its not because of the product, its due to my target audience who is primarily first time homebuyers.

I think a lot of lenders and realtors get confused with this product and due to that confusion decide to be negative about it.

Great Post!!

a lot of work here Mike, thanks, as usual. am getting over it now, just a bit left in the chest. focused on updating our market, then on to the meme thing. have a few ideas already.

cheers