For the past several years there has been a terrific need for better consumer information regarding “nontraditional” loan formats, the interest-only and option ARM mortgage products that have become so widely used.
Not only has there been a need for better information, there has also been a need for information from a neutral source — one not in the business of selling loans. Now, finally, there is such a guide.
Produced by the five federal agencies largely responsible for overseeing the banking system — “Interest-Only Mortgage Payments and Payment-Option ARMs: Are They For You?” — is a 16-page brochure that makes a number of important points regarding the newest rage in loan formats. Among other matters, the guide flat-out and in plain language says:
· “Your payments may go up a lot — as much as double or triple — after the interest-only period or when the payments adjust.”
· “Your payments may not cover all of the interest owed. The unpaid interest is added to your mortgage balance so that you owe more on your mortgage than you originally borrowed.”
· “Payment-option ARMs have a built-in recalculation period, usually every 5 years. At this point, your payment will be recalculated (lenders use the term recast) based on the remaining term of the loan. If you have a 30-year loan and you are at the end of year 5, your payment will be recalculated for the remaining 25 years. The payment cap does not apply to this adjustment.” (Emphasis theirs)
· “Interest-only or option-ARM minimum payments may be risky if you won’t be able to afford the higher monthly payments in the future.”
In addition to discussing the pros and cons related to interest-only and option ARMs, the brochure includes two important features.
First, the pamphlet has a useful “mortgage shopping worksheet” which poses a series of questions borrowers should ask when considering nontraditional mortgages. This sheet allows borrowers to compare lender offerings side-by-side. Print out several copies and you can evaluate many loan options.
Second, the brochure offers an interesting example with an $180,000 option ARM. The model loan has a 1.6 percent start rate and a 6.4 percent rate once the initial rate ends.
A borrower looking at this example will quickly see that payments which start as low as $630 in the first year will likely range from $1,308 to $2,491 in year six. In other words, in the best case the monthly cost for principal and interest will more than double. In the worst case, monthly loan costs could rise nearly 400 percent!
While there is much to recommend the new federal brochure, it does not plainly outline the consequences of not being able to make mortgage payments. The terms foreclosure and bankruptcy do not appear. The result of not paying a mortgage — the loss of a home — is not mentioned. The possibility of being forced to sell a home at a loss is not discussed.
In some places the brochure is muted. For instance, it says:
Lenders can end the option payments if the amount of principal you owe grows beyond a set limit, say 110 percent or 125 percent of your original mortgage amount. For example, suppose you made minimum payments on your $180,000 mortgage and had negative amortization. If the balance grew to $225,000 (125 percent of $180,000), the option payments would end. Your loan would be recalculated and you would pay back principal and interest based on the remaining term of your loan. It is likely that your payments would go up significantly.
Is it merely true that payments are “likely” to go up? Or is it a dead-on certainty? Given that the loan term is years shorter and the mortgage balance has increased from $180,000 to $225,000 — an additional $45,000 in debt — it’s difficult to postulate any real-world conditions under which monthly costs would not soar.
“The new nontraditional lending brochure from the federal government is substantially better than anything we have seen to date,” says James J. Saccacio, chief executive officer of RealtyTrac, the leading online marketplace for foreclosure properties. “This is information which needs to be in consumer hands. Both real estate brokers and lenders should be providing copies to consumers at the first physical meeting and copies should be available on all real estate-related web sites.”
To download your free copy of the brochure, please press here.
Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 90 newspapers.