Bill- I think many went into these loans with a promise that they would be able to refinance. But the lending criteria changed, and they can't refinance, or they wouldn't even qualify to buy in the first place in todays market.

Bill I don"t know about your area but in mine homes have not doubled every 10 years.

Bill, Just like any loan product these neg ams have their place in the market. The problem was selling them to folks that didn't understand what they were buying. Used properly they can certainly be a tool to help towards wealth building. Your example shows that very well. 

Bill,

I've been known to call these loans "Insidiously evil," but truth be told they are just a tool! So much of what we do and the programs we offer can be misused for evil, but it's not the program or produce that's evil it's the misuse!

Our programs are tools, like guns capable of incredible good or horrendous evil. Like guns there are people who fear the good even more than the evil, and will capitalize on, distort and exaggerate the evil to limit all our rights! Like guns there is evil misuse of loan programs, but there is a much bigger problem of use by untrained people!

If we're not extremely careful and actively defensive we'll lose our rights along with the tools of our trade.

Like guns no amount of laws will solve the problem, nearly as well as education, and the sure and certain punishment of those that violate the existing law.

Do I like Pay Option ARM's and Neg Arm's? No! Would I ban or limit them? No! Are these programs good for everyone? No! Are they good for anyone? Yes, incredibly good for many! What maybe wrong for some has allowed so many to profit. So many to succeeded.

You sir, call these loan "Wealth Builder's" and Col Colt called his "Single Action Army" resolver the "Peace Maker" both overwhelmingly correct, despite all the well known misuse! It was said: "God created men equal, Col. Colt made them equal..." can we say any less of what the sub-prime loans have done for home ownership? It was also said of the "Peace Maker" that it was the "the gun that won the west" surly a detailed look at what the sub-prime loans have accomplished leads to the conclusion that it's the loan the won the west!

Bill

William J Archambault Jr

The Real Estate Investment Institute

Bill- Neg amm loans are great for certain people, especially doctors and attorneys who are just starting their practices and know their income will rise as well. Katerina

Mark, This was not a defense of bad loans or badly constructed loan products. An arm that adjusts to a payment that can't be handled is criminal in intent. But a well constructed loan that won't adjust to a payment that can't be handled is a blessing to many. And the big issue is at what amount does the loan recast. A lender that wants to recast at 110% is taking unfair advantage of an uninformed borrower.

Bill Roberts

James, I think you need to look at the last 50 years and see if this hasn't been true over all.

Bill Roberts

BB, You're right, they were sold inappropriately, but they were also badly constructed with too high of a margin and made to recast at too small of an increase in loan balance. A good neg am was a godsend to many.

Bill Roberts

Bill, I can't defend a badly constructed Pay Option loan or a lender that made badly constructed loans but a Pay Option like the one from World Savings (now Wachovia) which would recast only after the balance reached 125% of the original loan amount is generally a SAFE loan for a qualified borrower. And their default rate supports that supposition.

Bill Roberts

BTW I like your analogy to Colt's Peace Maker.

Katerina, Your example is valid but the loan is also good for every day Americans who reasonably expect to make more money as time goes by. Our job as real estate professionals is to match this product with those buyers/borrowers who could truly benefit from it.

Bill Roberts

Bill, neg am loans remind me of stocks on margin because you can profit from the appreciation of the asset without paying the full amount to purchase the asset.  You can get rich in a very good market (100% in 10 years is a very good rate of return), but you can lose everything if the market goes sideways or down for a prolonged period of time.  Unfortunately some undersold the risk during the recent boom.

Frank, This is not a loan product for speculators. People utilizing this product need to have a five to ten year horizon. If they do then time will take care of them for no other reason than inflation.

Bill Roberts

Bill, looks like this post should have been on all the news stations in 2005-and beginning of 2006? Amazing how many people just didn't get it, or got it and now claim they didn't? Lance

Lance, I've been clamoring for higher standards for real estate agents and loan officers. If we had only good, well qualified people in these positions then this product probably would not have been abused. There were many ill-conceived Pay Option products available and unqualified LOs and real estate agents were touting their benefits, if for no other reason than they could make some easy money.

Bill Roberts

Bill:  This is a great overview of this type of lending option.  These loans, while a major mistake for many, are perfect for a good amount of folks.  The borrower should constantly be aware of the consequences and have a plan in place to be ready for the recast.  :)  Also... your response to James is on point... houses have steadily increased over the last 50...  just because the market is dipping does NOT mean that future profits are eliminated.  A friend forwarded an interesting video (roller coaster representing real estate prices) on that particular aspect: 

http://www.youtube.com/watch?v=kUldGc06S3U

It ends in 2007 (where's the 2008 dip?) so it may need to be updated.  Interesting nonetheless.

Bill:  I do hope you enjoyed the Roller Coaster Ride that Richard gave you a link to... that is so amazing.  That's been circulating since the early part of last spring.  These are wonderful loans for the right person... disastrous for others.  

Rich, I rode your roller coaster twice but it still didn't answer anything except that prices go up and down. There was no baseline or a view of the trend. It said it was adjusted for inflation, but inflation along with population growth and movement are the driving forces in real estate price escalation. It is not beside the point, it is the point.

Thank you for sending it along.

I appreciate your comments as well. This product has been bad-mouth enough lately. We need a more reasoned evaluation of this valuable tool.

Bill Roberts

Jan, the truth is that a well constructed Pay Option loan is not a disaster for anyone, but a badly constructed loan or bad underwriting criteria can turn a good thing into a disaster waiting to happen. We simply need better people making these loans. And better agents recommending them.

I assume that you've had a chance to read my comments to Rich about the roller coaster.

Bill Roberts

Bill this is an excellent description of pay option loans that includes both the benefits and the risks.  Frankly, it's the best explanation that I've read regarding the Option Arms.  Like any product, it has its place in the market.

As mentioned in the comments, the problem in our current environment is that they were used to buy on speculation.     Too many LO's were only selling this product at the height of the market.  They didn't understand the downside and therefore some consumers were put into a product that wasn't a match for them. 

Ultimately our job as professionals is to understand the products, understand the clients and match the two together!

Kate, You are absolutely right about our job.

The problem with this product is that all Pay Option loans aren't made the same. During the height of the market some lenders, GMAC and WaMu among them, had a high cost product (index plus margin) that would recast at 110%. They "bribed" uneducated and uncaring LOs to sell this product by paying 3 or 4 points of YSP in addition to loan origination fees. They had to know that most borrowers wouldn't be able to make their payments after the loan recast. Shame, shame on them.

On the other hand, the World Savings product which recasts at 125% is very safe. People that were able to get into their home using this product should be OK.

Bill Roberts

Bill, I think the reason why buying on margins and creative financing end up hurting most people in the long run is because they end up doubling their bet rather than stepping away from the table or at least diversifying their investments while they are ahead.  If the couple in your example turned around and did the same thing at the same price point and invested their wealth in a different type of investment, they could survive if the real estate market went sideways for a few years.  Unfortunately many instead reinvest their new wealth and risk everything on a more expensive property or several properties.  That seems to have been a big issue in the southwest where speculators were flipping and reinvesting in a geometric fashion.  When the market goes through a short term correction, their loans recast and their wealth goes back to zero.  It's similar to getting a margin call after you've already invested all of your money on the margin.  I'm sure you would advise the couple to spread out their new wealth to avoid such a calamity.

Frank, You need to make a distinction in your mind between a homeowner and a speculator. I never did any business with the flippers. I had the opportunity but I declined. Also, there is a difference between speculators and legitimate investors.

I would be happy to sit down with you and explain the merits of this product for investors who choose (make a conscious choice) to use their house as a bank and invest (not speculate) in other vehicles to grow their wealth. To a great many people they "feel" safer by spreading their money over several different investments rather than putting all their eggs in one basket.

A good case can be made that paying down your home loan at the expense (opportunity cost) of other investments is very risky. What happens if they suffer some reversal in their life and they need money. They may not be able to refinance at that point. Having other investments that can be liquidated gives them options and more safety.

Your allusions to gambling are telling. Investing in real estate should not be a gamble. All real estate investments need to be made on solid criteria. Anybody who lives his life by putting everything at risk deserves what befalls him. Wealth building is about security not risk. We are not talking about borrowing all the equity out of a house and gambling with it. That would be foolish at best.

Also,  I think you need to know the difference between reset and recast. Adjustible Rate Mortgages can be RESET when certain criteria are met: time and change in the index. This will change the interest rate the mortgage earns for the investor (which is how we refer to the lender).

Pay Option Mortgages can be RECAST when the loan balance reaches a certain pre-determined ratio of the original loan. This means that the borrower can no long make minimum payments but must make a payment that will retire the mortgage in a stated number of years (fully amortized).

A lot of people confuse these terms and their effect. An ARM that is going to reset might have little effect on the borrower if he can still make minimum payments because the loan hasn't recast yet.

I hope this makes it clear. As I said, I would be happy to sit down with you and go over this in depth.

Bill Roberts