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The Triple Whammy: Sinking Into Adjustable Rate Quicksand

Now, why would anyone be afraid of a little old adjustable rate loan, going up just a little bit, in just a little while? Well, one thing that was not mentioned in Michael Mape's blog today was what I call THE TRIPLE WHAMMY that occurs when an "interest only" loan adjusts. Here's how an adjustable can blow up in your face:

WHAMMY # 1: Because you have only paid the interest, you still owe the entire amount you borrowed. However now that original amount will be amortized over 25 years, NOT 30 YEARS. This is exactly like starting all over again, but with a 25 year loan. (the shorter the term, the higher the payment)

WHAMMY # 2: You have become used to paying interest only, but now you must pay PRINCIPAL and INTEREST (Now, you must begin to pay the loan down, so you are paying more each month to cover the principal.)

WHAMMY #3: Your first adjustment will most certainly be at a HIGHER RATE (because rates are higher than they were 5 years ago)

Now, any one of those things alone might be a little scary, but put them all together, and it can make a tremendous change to your payment. For example (and this is a real example of a refinance):

Original loan of $550,000 was at 4.5%, interest only. Payment = $2062

Original $550,000 with Whammy #1 (squash loan into 25 years) & Whammy #2 (Add principal to interest only loan). Payment = $3057

But, WAIT! We still haven't added the new interest rate. This loan has no cap on the first adjustment, but a 2% cap every year beyond the first adjustment. Index 4.12% + Margin 2.75% = 6.87% New Rate. (Add Index to Margin to create new rate) Payment= $3842

Okay, new payment on this jumbo loan after TRIPLE WHAMMY is $1780 higher. Can you say OUCH? Well, my client did.

Now what if your house is exactly like your new Lexus....You owe more than the house is worth? This might be the result of declining values in your area, an original loan that was 100% of the value, or the fact you placed an equityline behind your adjustable rate mortgage sometime during the 5 years. (or a combination of these factors)

And what if you are no longer able to do a stated income loan due to tighter guidelines? Or cannot qualify for another reason?

Now what? Do you see why making the broad assumption that "WE WILL JUST REFINANCE OUT OF IT?" is an assumption you simply cannot afford to make? Can you see how a combination of rising rates, declining values, and an artificially low payment can bite you in the behind?

Please make no more assumptions and get your head out of the sand NOW. That sand could turn into quicksand.

Posted by Janet Guilbault California Mortgage Banker/Broker on 10/09/2007 06:47 PM

Comments (17)

california mortgage expert, adjustable rate mortgage, declining values, equityline

17 Comments on The Triple Whammy: Sinking Into Adjustable Rate Quicksand

OCT

2007

Hi Janet! You make an excellent point! You example was very easy to follow and very informative. Thank you! Good luck to you and to your client!

Janet.. Once again this is a great product for certain people who know how to use it to their advantage but it is not something that should be used by the general public ... especially those who can barely qualify at the introductory rate..

Pattie: So glad you found it easy to read. Sometimes this mortgage stuff can be a tough read.

Kaye: Right you are! But beyond the qualification issue, most never consider how their mortgage adjusts. Something so important, and most people have no idea until they talk to a mortgage broker...and usually NOT the on that did the loan.

Janet, I think I will consider making your blogs required reading for my clients! Wish you practised over here in Michigan. Once again, an excellent post....simply excellent. Thank you.

All this and your house is now worth much less than you originally paid too! OUCH, OUCH, OUCH, OUCH!

The Truth Hurts - Great Post

Great and easy to understand explanation here. Thanks.

Hey Janet - how about the quadruple whammy! - take that example above and use it on one of those pay option arms after they recast in 60 months....... WOW!!!

GREAT BLOG!!!!!

EXCELLENT!!!

I hope you've posted that to localism. I think it places things in perspective for so many realtors and consumers alike!

OCT

2007

Lola: Nice compliment! Thank you SO MUCH.

Lisa: Yes, and it becomes the mortgage broker's job during a refinance to inform the buyer his house is worth much less. This part of my job is so difficult and makes me feel for you as Realtors.

Rebecca: Well, actually the truth that really hurts is how mortgage brokers have encouraged people to never even consider what might happen if the rate adjusts. Some don't even understand how this works!

Tracey: Ever since I saw your Tomato Blog I cannot get that pumpkin with a comuter screen out of mind. You are a marketing genius! Seriously.

Lewis: I actually considered making a quadruple Whammy!!!! But did not think about the option ARMs. I only did a couple of those loans to investors....but I have had to refi many of the loans described in this blog. To date, I have not talked to even one client who had the foggiest idea how to calculate their new payment. It is like the great mystery of the mortgage world.

Bill: I just re-read it, and you are right! I should have posted it to localism. I am guilty of thinking because it isn't about a certain area, it isn't "local".

OCT

2007

Excellent post!

Bob Mitchell

ValueList Real Estate Services, Inc.

OCT

2007

Hello All,

What can be truly disturbing is what I call the "Me, Mine, Now" policy. That is when a mortgage broker is only concerned with their own commission and they tell these clients that "We can just re-fi in a few years." These are the people that are feeling the triple or quadruple whammy. Realtors are not immune to this policy. As a real estate broker, I try to train all of our agents that the client is always first.

Now take into account that the standard POA loan will recast a lot sooner than 60 months. Most POA loans will recast in 24 to 36 months if the minimum payments are made every month. Do these people have a hard pre-pay? They probably do. Was this explained? Probably not.

I am not throwing stones at mortgage brokers, I am a mortgage broker. We have seen many people recently who are ready to just give up because of a serious lack of education while getting the original loan for the home. We have to remember that not everyone is a loan officer or Realtor. Break it down to simple terms and make sure your clients understand what they are getting into.

I want to add that I agree with the above compliments on your post. It was informative and easy to understand.

Shawn

OCT

2007

Janet, very good information. Yes, it's a mess. I am currently working with several clients that got themselves into ARMs but the time has come for them to adjust. Problem is, their credit is still tanked. The only way I see for them to get out is to either sell or get their credit fixed up. One of these clients finished the process and will now be able to refi - even though the primary changed jobs recently.

Russ

HI,

What does the whammy #1 and #2 have to do with an ARM. Just because you have an ARM doesn't mean that you have an interest only loan???

Kris: You make a valid point. But almost every adjustable rate mortgage here in Calif. WAS interest only. Maybe that was not the case in your state.

Also: very few 30 year fixed rate mortgages were interest only. I did write some of those, with a very strong caution...because at the end of 10 years, if you pay interest only, you end up with a 20 year loan.

OCT

2007

:-)

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