- The Washington Times - Wednesday, May 30, 2007

As a homeowner, I continue to receive mail solicitations touting so-called “option ARMs,” which are monthly adjustable mortgages that allow the borrower to make a minimum monthly payment that doesn’t cover the interest charged each month.

The unpaid interest, called “negative amortization,” is tacked onto the loan balance, resulting in an increased debt level each month.

Although the media overwhelmingly has portrayed these products as bad for the consumer, mortgage companies continue to market them heavily as a way to increase purchasing power. I have written about these products before, and they need to be addressed again.

The most important thing about option ARMs, in my opinion, is not the ability to make a low payment, but the actual interest rate on the loan. The “payment rates” as low as 1.50 percent touted on the influx of misleading advertisements have nothing to do with the actual interest rate of the loan.

For example, let’s say we have a $300,000 mortgage with a 1.50 percent minimum payment rate based on a 30-year amortization. My calculator tells me that the payment would be just $1,035 per month — pretty low for a $300,000 principal balance.

The problem is that the actual interest rate on this type of loan is running closer to 7.50 percent, making the actual interest charged $1,875 per month. The $840 difference is tacked onto the loan balance. It’s easy to see that when the buyer makes just the minimum payment each month, the initial $300,000 balance can go up quickly.

During the first half of this decade, short-term rates were at rock bottom, thanks to the Federal Reserve’s interest rate cuts after the September 11 terrorist attacks. In fact, some monthly adjustables carried interest rates as low as 3 percent.

Because short-term rates are largely governed by the Federal Reserve, it wasn’t difficult to determine when those rates were going to go back up because the Fed made known its intentions of raising rates well ahead of time.

I don’t share the media’s criticism of option ARMs, although I certainly agree that they are not very good products in this interest-rate environment because rates on 30-year fixed programs are a lot lower. Why take a riskier monthly adjustable when you can take a risk-free 30-year fixed program at a much lower rate?

The answer is simple: Folks want a low payment so they can increase their purchasing power.

Is this a bad thing? It very well could be if it puts a borrower into the position of buying a house he or she cannot intrinsically afford.

The mortgage originators who mislead the public about these programs and focus their efforts on selling a low payment rather than explaining the details of option ARMs are not just unethical, but probably behaving illegally.

If you have an option ARM, it might be a good idea to consider refinancing to a fixed rate. If you find that the new payment is too high, consider a 30-year fixed-rate program with an interest-only payment option. The interest rates will still be lower than the ARM, and your negative amortization will go away.

Remember my mantra: If you are considering refinancing, avoid paying any points and keep your closing costs to a minimum.

Henry Savage is president of PMC Mortgage in Alexandria. Reach him by e-mail ([email protected]pmcmortgage.com).

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