Chances are if you’ve been reading about Negative Amortization mortgages, you have been warned off of them. Consumer groups are up in arms about these mortgages, but it isn’t really the product itself that is dangerous. Misinformed borrowers that are uneducated about payment option ARMs can get themselves into big trouble. Mortgage brokers not offering full disclosures and educating their clients are also part of the problem. However, if you understand how the mortgage works and are in the right financial situation, it might be the right tool for you.
Payment option ARMs are one of the most complex loan tools available. The payment option ARM mortgage typically offers four monthly payment options. The borrower can choose to make any one of these choices which normally include a fully amortized principal and interest payment, interest-only payments and even deferred interest payments. This keeps monthly payments low – for a while, but can get uneducated consumers into trouble.
Pay Option ARM offers you several monthly payment options:
o Principal & Interest
o Interest Only
o Negative Amortization
o Option ARM MTA or COFI
By paying interest only payments, the amount owed remains the same instead of decreasing. By paying the minimum payment, which doesn’t even cover the interest, the amount borrowed increases instead of diminishing. This is negative amortization. Once this balance reaches a certain amount, the loans are automatically recast at a higher rate and the payments increase. According to Fitch Ratings up to 80% of all option ARM borrowers make only the minimum payment every month. Also the lowered interest in the introductory rate, sometimes as low as two percent generally only last a month and continue to change each month. The minimum payment raises a maximum of 7.5 percent a year, but that adds up. Consumers that did not understand their mortgage may find they cannot make their payments and owe more than their initial loan.
“Consumers should really be careful to understand that affordability shouldn’t just be gauged by the introductory or first year rate, says Eric Ewald, managing director of the Minnesota Mortgage Association.” Although misunderstanding these loans is dangerous, they are an excellent tool for consumers who are not living paycheck to paycheck, can anticipate a significant boost in income or have low monthly income but large annual bonuses. The flexibility of an option ARM can really be a blessing to some borrowers, but only if they understand how the loan works.