Brian Brady is making a case for Option ARM loans . I fundamentally agree with him. In the hands of a savvy investor, Neg-Am loans can be an ideal solution.
Brian, I have no doubt that YOU know how to structure one of these loans. But that thread of comments on Active Rain reflects why these loans have the terrible reputation they have. And that’s the true problem with these loans. Even LO’s who think they know how to use them, often do not.
I haven’t looked at a rate sheet for a long time now, current rates could be different. But for the better part of the last decade, Option Arms are a bad deal. Not because too many people use the min payment, but because the wrong people were using it.
Everyone can see that unsophisticated borrowers without the fiscal responsibility should not be in a product that trades equity for a nicer car, or premium cable, or a bigger house than they really qualify for. Let’s not even go there. Everyone agrees this product was massively misused.
However, the other side this product that few people consider is that those with fiscal responsibility are often wasting their money on this loan as well.
You see, the Option ARM is often a bad deal for people who DON’T make the minimum payment.
You did read that right, but before you start commenting, please hear me out.
Neg-Am loans work when the capital saved over a regular interest only loan is is properly invested. Option ARMs gained popularity earlier this decade as they became a more widely available way to acquire a neg-am loan.
For the most part, the people who took these loans, made the minimum payment, and invested the savings were the only ones who truly benefited.
The people making options 2-4 on a regular basis, probably could have saved a bunch of money. The reason why, was that there was almost always an interest only loan without any prepayment penalties available with at a better price. For six months around 2003/4, I sold a 30yr amortized one year ARM that was priced low enough that a borrower could make their P/I payment on our product for less than the I/O payment for a WaMu Option ARM.
That’s the real problem. The Option ARM was a gimick. For all but the savviest of investors, they were’t the best case scenario. Even folks who did use the Neg-Am part, really didn’t need the other options. Lenders profited off of the guise of convenient payment options that most borrowers only thought they needed.
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And what we’ve learned at this point is that there really are only two options with the Option ARM.
(1) Keep Your House
(2) Foreclosure
You are right. For those who didn’t use the option provisions to make savvy investments the loan didn’t make sense. Lower rates and better terms for the money were widely available.
For those who relied on the minimum payment to keep the roof over their heads–Paul nailed it; they are likely to be enjoying the hospitality of a local shelter and wondering what the hell happened…..
Right you are, Todd. It was marketed to the masses and only the intro rate or intro payment was misleadingly (is that a word?) highlighted in the ads to infer that was the rate or payment for the life of the loan. What a dupe on the consumer, it’s gonna take a long time to clean it up and for the trust to rebuild in our industry.
Todd… I’m glad you brought up this multi-sided issue that touches on many things. Option ARMS are beginning a premature bust because of people let them negatively amortized. I touched on this in my Lenderama post: http://blog.mariah.com/2008/07/the-question-nobody-wants-to-ask-and-the-answer-everyone-wants-to-have/
I link to the recast figures in the post.
Very few people (consumers, financial planners, mortgage professionals, institutions) understand that Mortgages are financial instruments. Suitability is CRITICAL when choosing any financial instrument as it acknowledges risk appropriateness.
Having worked on the inside of one of the major purveyors of this product I can support the assertion that it is a product that has HUGE margins and is was never supported with any suitability training for the LO or the consumer. The fact that most were sold with pre-payment penalties furthers the fact that it was a money grab.
Regarding the arbitrage potential of these loans. We should try putting together some hard numbers on these loans vs. the indexes they are tied to and the S&P returns. Over time, I think we’ll find that this has been a pretty good strategy for the wealthy and disciplined investor. The past 3 years or so have been an anomaly as foreign markets continued to pump liquidity into our Mortgage Backed Securities inverting the yield curve and collapsing the delta between short/long-term monies. This has eliminated in many cases the Option ARM Arbitrage potential.
Well it is pretty obvious that unless you were saving the difference you were screwing yourself with these. The option ARM is a tool that can be used for good or bad depending on who’s hands it is in.
Chad C.
LOL…good one, Paul
Todd: I absolutely agree. Most consumers need to stick with fixed rate or very simple ARM products. A careful and well trained loan originator who take the time to know the client, like Brian, can use exotic loans for sophisticated consumers. Even then, consumers who are not financially savvy but might seem sophisticated ought to beware.
Worst part is that most of the lenders who conned people into unmanageable loans are now themselves in trouble, and they’ve bringing down a lot of people who did make right choices, but since equity values have fallen so badly, they’re left high and dry.
Nice to see your take on this. I just read Brians post a little earlier. I think the issue is that besides effecting banks and borrowers that dealt with these loans the neg-am is effecting taxpayers that never took on these loans.
And in that sense the argument that some people know what they are doing doesnt really work. In the same way that its not a good idea to allow people to build bombs in their apartment because “some people know what they are doing”.
Unfortunately for my past Las Vegas clients in 05 and 06, I closed several option arms. Haven’t touched one since, but we were busy strapping people with neg am loans for those two years.
I am heartbroken over the position some of these families are currently in. Credit, security, and even marriages are totally destroyed.
However, I always go over a custom spreadsheet with my clients that compares 4 - 12 different mortgage programs,rates, down payment, monthly payment, closing costs, and term. Even though my application and interview process is extremely thorough, I still have clients who are more motivated by today’s payment vs tomorrow’s financial security.
So, the rhetorical question remains -
How much education and disclosure does a mortgage professional need to provide before the borrower should accept responsibility for their own decisions?
I fully agree that there were plenty of predators who pitched option arms with 3 yr. hard pre-pays and 4 point margins.
At a certain point though, a $750 monthly payment for a $500k loan amount has got to raise some questions from a responsible adult researching mortgages in that price range.
“At a certain point though, a $750 monthly payment for a $500k loan amount has got to raise some questions from a responsible adult researching mortgages in that price range.”
Consumers want to trust the pro and if the pro says it is okay, they’ll go for it. For most people, it’s like a parent child relationship.
Many years ago when I transitioned from origination to underwriting I thought I would be the “nice” underwriter and approved some marginal FHA credit cases. I saw a few of those families go right into foreclosure the first year and that’s when I learned that responsible lending like responsible parenting is all about tough love.
“I learned that responsible lending like responsible parenting is all about tough love.”
Great point, Diane.
So, where does a loan officer draw the line between tough love parenting and allowing their client to make an educated decision?
I agree with you on this topic, so please don’t think I’m being difficult. For the sake of conversation, these are questions that have been challenging to answer in my own business.
I think there are two answers to that question depending on who you are in the lending process. A good originator should consider suitability when presenting products. A good underwriter knows how and when to say no, even if the consumer or the loan originator disagree.
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