Tempting Low Payments

Until recently borrowers using option ARMs would face the immediate reality of negative amortization. Starting with their first monthly bill they would be given the option of making a super low mortgage payment, far less than the full amount of interest due. In most cases this low payment option would be less than half of the full amount of interest due on the note. The difference would, of course, be added to the mortgage balance.

Inherent Risk

Some borrowers used this program responsibly and paid up the growing deficit from time to time, or simply let the balance grow knowing that they had the resources to face the consequences when the time came. In truth, the vast majority of borrowers that financed their home with option ARMs never paid more than the minimum payment. Over the last decade, as home prices increased consistently, a growing mortgage balance had little or no impact. Florida home prices tripled during this period of time. Other parts of the county matched or exceeded this growth rate. Many smart borrowers rode this wave and used these programs as a way to have a tiny payment while enjoying dramatically growing equity.

The Beginning of the End

But times change. In June of 2004 the Federal Reserve begin raising rates, an effort that would not stop until June of 2006 after seventeen rate increases. The impact on option ARM borrowers was dramatic. The obvious impact appeared each month on their mortgage statement as they watched the index, which controls the underlying cost of their mortgage and hence the amount of negative amortization, increase month after month. But the real impact was initially less visible.

Real Estate Values Fall

As the Federal Reserve continued to increase interest rates real estate prices, which for over a decade had done nothing but go up, now stalled. Over the next two years all upward movement in home values vanished and the worse case scenario began to come true. Real estate values began to decline. Home owners with negative amortization home loans suddenly found themselves with growing mortgage balances and shrinking home values.

Tough Choices

This insidious situation was compounded by the absence of a clear choice for these borrowers. Our Florida mortgage customers facing the red hot real estate market of the last decade often selected these loans as the only feasible means of purchasing homes with an affordable payment. To refinance into a fixed rate mortgage could easily double their payments. For many it was far easier to ignore the situation, perhaps hoping that home values would recover. This hope, no doubt, will eventually bear fruit and home values will stabilize, both in Florida and elsewhere, and begin again to climb. But for the moment many of these option ARM borrowers are looking for more immediate solutions. A new option ARM has appeared that many borrowers are selecting as a feasible refinance choice.

The New Fixed Rate Option ARM

This new product offers two unique and attractive features that add considerably to the security of this otherwise volatile home loan. Whereas old versions of the program required an increase in the monthly minimum payment each twelve months, this new product allows you to make the initial minimum payment for up to ten years or until you reach your negative amortization cap. In other words you can continue making the initial tiny payment until your loan balance grows to a predetermined limit, which is usually twenty to twenty-five percent above your original loan amount.

Predetermined Balance Growth

The second new feature provides an additional dramatic selling point. Old versions of option ARMs had no caps whatsoever on the underlying interest rate that would determine the amount of negative amortization that could accumulate. This new program fixes the underlying interest rate for a period of time that matches the fixed minimum payment that I described above. This means that, although your mortgage balance will still grow, you will always know exactly by how much. In other words, for the period of time you select for your minimum payment privilege, this is not an adjustable rate mortgage!

Your Choice

This new product is still a sophisticated mortgage that is best suited for responsible borrowers that full understand how it works. As Florida mortgage brokers we are vigilant in assuring that our customers fully grasp the details. This is simply not the right program for the many retired borrowers that we service. Negative amortization will still accumulate, although at a predetermined pace, and this must be understood. But for the right person the new features build into this program provide an exciting way to enjoy a diminutive payment with out the uncertainty built into previous incarnations of negative amortization loans.