I have been in the mortgage industry for 20 years. (that would be 3 life times in the mortgage business!). One topic that always pops up when markets shift is “option arms”. I don’t want to go into a complete dissertation on option arms at this time, I will go into them more in depth in the future. I want to cover some basic information on them.
So, the first question is what is an option arm?
Option arms are adjustable rate loans that offer 3 to 4 different payment options each month.
Option 1: Minimum payment based on the initial start rate.
Option 2: An interest only start rate.
Option 3: Principal and interest on 30 year amortization (some are 40 year)
Option 4: Some lenders do offer a 15 year principal and interest payment.
In the last 12 months or so I have read a number of articles, that I believe were not well researched by the authors. Each article I read was in a major metropolitan newspaper. Some of the articles referred to option arms as “new fangled loans” “exotic options arms” and of course my favorite “risky interest only loans”. The latter could also be referring to interest only arms fixed for 3,5,7,or 10 years. ( I don’t find them that risky myself and I am about as conservative as you can get!)
First and foremost THESE LOANS ARE NOT NEW!!!! I don’t consider them “exotic”, derivatives on Wall Street are exotic. I also do not consider them risky, although we all have our opinion on what is risky.
Option arms were developed by the savings and loan industry to promote home ownership. Now an astute person may say “well what about the savings and loan crisis?” Why did they all go out of business? The main cause of the demise of the S&Ls were their commercial loans. The goverment allowed them to stray into commercial loans and they did a very poor job in that area. Please make a note, not all S&Ls had this problem. Some stuck with home loans only and ended up merging with other S&Ls and converting to the FDIC as banks. So………..back to the option arm genisis.
Option arms were developed to give clients the option to make different payments and at the same time protect the banks against rising rates. That way the bank was protected and the client has as well, since they could make different payments. The banks were and are not now, in the business to take property back! Taking back property is not a profit center for them, it is an expense! The loans were designed as a balance for all involved.
I personally think these are excellent loans, but THEY ARE NOT FOR EVERYONE!. We strive make sure we have the right client in the right loan. If it is an option arm, we strive to make sure it is understood correctly. There are many abuses by lenders when it comes to this loan and we strive to avoid that with clients. We use spefic spreadsheets to explain them in black and white. Many, many lenders do not even understand the loan let alone explain it correctly.
In the future, I will go into the different indices offered on these loans, what type a client are these loans good for and who they are not good for. I will also cover a bit more on the history side as well.
One last note, if you have this type of loan and you are concerned about rising rates, don’t panic. Rates will eventually cycle down as well. When we do not know, but they do. My advice is do not fall victim to lenders who call you up and tell you “you have to get out of that loan”! Lenders have a habit of telling someone in an ARM that they need a fixed rate and someone who has a fixed rate that they need an ARM. Make sure you are working with someone who has your best interest at heart and not theirs.
Until Next time,
Home Services Lending