Every investment vehicle and financial program under the sun has some sort of risk attached to it. Whether it is stocks, bonds, stock options (deep in the money/out of the money) puts, arbitrage, stock shorting, derivatives, mergers, Real Estate Investment Trusts, etc. The key is managing the risks within suitable parameters while superimposing an investment template and guidelines over the investment.

Many have used the Option Adjustable Rate Mortgage for consumer home purchases and some are in deep do-do for never understanding exactly what the downside held for them. Many wealthy people have used the Option ARM in combination with financial planning, as they knew exactly what to do with the payment difference between the fully indexed payment and the option payment. They put it to work to more than offset any negative amortization and have benefited. A well-known lender proponent of this vehicle structures the deal with an 80% or lower LTV (Loan To Value) and offers a biweekly payment schedule. This allows the borrower to pay the loan off in 21 to 22 years by making one extra payment per year thereby shortening the term and saving 8 to 9 years of payments. This can make for tremendous savings while working within the program guidelines. The problems started when the Option ARM became morphed by new players in the game by allowing Piggy-Back Second mortgages behind the potentially negative ARM thereby putting more pressure on the borrower to keep up with the adjustments during the current mortgage upswing. Typically the monthly payment has a 7.5% built in escalator per year for the first five years with an additional limitation of the amount of negative amortization (original mortgage amount goes up) 115% of the original loan amount. During an accelerating real estate market the appreciation has kept ahead of the negative amortization. For example: If a borrower had an original 80% LTV loan of $450,000.00 and the difference between the fully indexed rate (fixed margin percentage and the variable index used) and the minimum payment amount was say 6% less and neighborhood prices per appreciating say 11% per year fine. Even with say 3.5% inflation a borrower would be ahead of the game in this scenario. Keep in mind, the 11% appreciation is taking place on the total value where the negative amortization is effecting the mortgage amount only. As long as this scenario carried forward for say five years the borrower could be still be ok. However, when the market turns suddenly, the borrower could be upside down (owe more than the property is worth) in short order.

The best evidence of the sudden turn of events is in monitoring the foreclosure rates of ARMS versus Fixed rate mortgages. In many areas, there are steep rises in these programs. To complicate things, hybrid OPTION ARMS have found there way into ALT A market with borrowers demonstrating less than stellar credit, employment, assets, etc. or a combination of all the aforementioned. With this combination and perhaps a Piggy Back Second Mortgage making for an initial 95% to 100% Combined Loan To Value the handwriting has been on the wall for major problems when a downturn occurred in property values. There will be foreclosures, short sales (lenders settling for less than what is owed) and much agony experienced by borrowers, but eventually it will work itself out. Regulators are already touting closer regulation of Option ARM and other mortgage hybrid products that may pose a danger to the consumer.

Page 1 of 3 :: First | Last :: Prev | 1 2 3 | Next