Smart Borrower Blog

What Happens When Option ARM’s Reset

Feb 17th, 2008 @ 4:01 PM by Alden Smith

Just when I think I am beginning to think that I am getting a handle on the mortgage market, I learn of something new that is considered a real bane to the industry. While researching today for the post, I came across an article on a type of ARM that I have never heard of – the payment option adjustable rate mortgages. I have read that this is indeed a very complicated mortgage to understand and that many homeowners who have made this type of loan are facing big trouble. Many of these loans are due to reset in the near future, causing a lot of pain to homeowners who have them. Here’s how it works – the borrower gets to chose how big of a check to write each month on the mortgage, which already sends me danger signals. This mortgage was originally designed for a few select buyers, but was put to good use during the housing boom by builders who wanted to unload newly built homes. Now consumer advocates are reporting that these loans add thousands of dollars to the cost of the mortgage, and when we have a situation as we do now, and house values are falling, it puts the owner into even bigger trouble. So what’s the problem? What is happening is this – the loans made using this options are due to reset in the near future, and homeowners are going to see a huge jump in their monthly mortgage payment. If they can’t keep up the payments, that money gets tacked on to their old loans, creating bigger loans with bigger payments. If they can’t afford them, and if they can’t refinance because of dropping home values, they are looking foreclosure straight in the eye. Originally, these mortgages were designed as truly creative financing. They had many options to help a person who understands not only mortgages well, but has an excellent knowledge of finances in general. This is not your average Joe. The options include the ability to make a smaller “minimum” monthly payment, and the homeowner has the option to make bigger payments, so that they can effectively pay off a 30 year mortgage in 15 years. This type of mortgage is great for people who have an unpredictable income, such as salesmen who rely on commissions, or self-employed people. The problems begin to rise when unethical lenders based these loans on a person’s ability to make the minimum payment, and not the higher optional payment. The average option ARM can also mean that lenders have the option to change monthly interest-rate adjustments, meaning some borrowers face new, higher rates sometimes even before they make their first payments. Unethical lenders took advantage of the fact that most people don’t even take the time to read and thoroughly understand the paper work of the mortgage, and some are so desperate to own their new home that they are willing to sign just about anything that will put them into their dream house. These loans reset in about 5 years, and many of these resets can be as much as 115% of the original loan. So, if you originally borrowed $100,000, for sake of argument, it would reset to $115,000. The lender effectively issues a new loan for $115,000, and the process starts over. This mortgage is on the analyst’s charts as the next big bust following the sub prime mess. The ride isn’t over yet, it seems.

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