Anthony: But what about those adjustable rate, “negative amortization” mortgages with a PRE-PAYMENT PENALTY the first 3 (or more ) years?????

Steve: That was the program that I referenced as “Option Arm”. I understand that there is negative amortization involved but some people don’t have a problem with that. I do believe that people who only have 10% or less equity in their home are at huge risk considering your balance is going up monthly while there is a posibility of your home depreciating at the same time. The pre-payment aspect of this program is not always three years…There are options to have no pre-payment penalty, one year, two years or three years. All of the different pre-payment options have different pricing involved. You might have to pay a little in origination for no pre-payment…no points for 1 year pre-pay…or even get a credit for closing costs for a 3 year pre-pay. Essentially, this program is not going to end in forclosure if you have a 300k mortgage on a home valued at 700k. The people that might feel the pain are those who owe 450k on a home valued at 500k. In that scenario a 7% decrease and 3% in deferred interest would make this person upside down…no so good. The person that has a couple hundred thousand in equity will still have an out and ultimately just net less if they chose to sell.

Steve and I are both seeing big problems with these Option Arms and starting to wonder if the buyers really knew what financing package they were buying into. I met with yet another nice couple over the weekend who has had $12k negative amortization since the beginnning of the year and is saddled with a program that imposes a prepay penalty for three years if the home is refinanced OR sold. With a small down payment initially and a softening market, they are understandably concerned. I don’t know whether, in these cases, the consumer was not fully educated before selecting the loan or whether they didn’t consider (or want to accept) the possibility and implications of a market downturn and rising interest rates. Either way, I think we are going to see this as more and more of an issue as time goes on. Thanks, Anthony, for the insight.

Wow…that is a lot of deferred interest in 6 months. Was it a high purchase price? I think that I mentioned it in my post but there is no reason for a 3 year pre-pay unless the lender is giving the client a real low margin, paying for the clients closing costs or just being greedy and making the most money possible and taking advantage of an uneducated client. I think that it is a mixture of both people having blinders to what might happen and lenders not fully explaining the programs ups and downs. I’ll go one step further in the scary aspect of these programs in that people max themselves out on the minimum payment portion of this loan. People you can’t afford this home and this program if you can only afford the minimum payment…the payment will automatically, without choice, go up 7.5% of the previous years payment on the first anniversary. 2,000 payment goes up to 2,150…and so on for the first five years…if you can only afford 2,000…not so good.

Anthony: I agree, to a certain extent, with both you and Kris. But let me be a little more specific than Kris. We are getting numerous calls from people on these Option Arm loans, desperate to find a way out. Now I know you and other reputable lenders explain both the upside and downside potential of these loans to borrowers. However, a potential problem is that, like in the case of real estate agents, not all lenders are as reputable as others. Regardless, I have the feeling that this issue may start to enter a “legal realm” soon (i.e., litigation) as more and more borrowers start to feel the pain.

Steve: I also agree with you to a certain extent…I agree that some lenders are not reputable and some people don’t really understand what they are getting in terms of loan. I do not agree with the premise of “litigation” for these types of loans…at some point the clients have to take some responsiblity. If the market was still moving upward, I don’t think litigation would be mentioned in these discussions. I think that if we buying an 800k home and we want to reap all of the benefits of owning that home…we can’t release ourselves from all the downside of the home we chose to purchase and the loan we chose to obtain.

You know, Anthony, I like your comment about taking responsibility. We complain about it on the sale/purchase side, and it stands to reason that this would be an issue for you on the lending side as well. The bottom line is that if the real estate or lending consultant is properly advising the client of the particulars of a situation, the client needs to take the ultimate responsibility for the decisions they make whether they relate to a property pricing, the purchase/sale contract or a lending relationship. Unfortunately, when things go wrong down the road, it is all to easy to make the Realtor or Mortgage Broker the goat.

The reality is that many people DON’T like to take responsibility when things go south (although some, a minority, actually do). It’s an unfortunate byproduct of human nature. I don’t disagree with your premise, Anthony. People SHOULD take resposibility. I’ve just been around long enough to, intuitively, feel that someone, somewhere who is upside-down financially, is going to go “legal” with their Option Arm and when that happens, the risk of a snowball affect gathers strength. I only advise caution to all in this matter. Thanks for your great insight.