Should Payment Option ARMs be Banned Because of Negative Amortization?


Much has been said in recent months in the media about the dangers of payment option adjustable rate mortgages that include a negative amortization option. Uneducated borrowers can quickly find themselves losing their homes. There has been so much clamor that many authorities are demanding that negative amortization mortgages be banned.

However, many lenders disagree. Regina M. Lowrie, chairwoman of the Mortgage Bankers Association notes that, "A one-size-fits-all underwriting standard will unnecessarily choke industry innovation and diminish consumer choice." She also states that, "The non-traditional loans are important options for homeowners who need cash to make home improvements, to pay medical expenses or send their kids to college." Banning the loans is not the answer. The better solution is proper disclosures and better financial advice. Loan officers should present both sides –the pros and the cons of exotic loans so that consumers can make educated decisions.

An option ARM is an adjustable-rate mortgage with four choices of a payment each month. The borrower can pay the amount necessary to pay the loan off in 15 years or in 30 years, pay only the interest charged in the previous month, or the borrower can make a minimum payment that doesn't cover the interest. This is considered deferred interest and the loan balance increases. Payments are determined by LIBOR, MTA or COFI index rate and to determine the adjustable rate margin (ARM), lenders add to the index rate a few percentage points, called the "margin". It is a complicated mortgage, but for a savvy lender in the appropriate position, it can be a smart choice.

An option ARM can be an appropriate and helpful loan to borrowers who know their income will increase dramatically in the coming years. It can also be a great loan for individuals with inconsistent income and annual bonuses or those that plan to refinance or sell quickly.

If the lender does not plan to get out of the loan quickly, they should keep in mind that it is difficult to get a second mortgage behind payment option ARMs. The negative amortization of Payment option ARMs can hinder future subordinate loan options. Underwriters calculate the 1st mortgage balance by gross up balance of 115% or 125%, depending on the mortgage note. So consider whether you may need a second mortgage before you get a payment option mortgage. Very few home equity lenders will go behind a negative amortization 1st, although like all loan products this also depends on your credit. Find a lender that will help you make the best decision and make sure you fully understand the loan you choose.

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