Home prices have hit all-time highs, and in many parts of the country, it's almost impossible to buy a home.
In the late 1990s, tech stocks were the hot investment, but now real estate is. Everyone has sold their stocks and bought investment property.
Real estate prices have gone up at a much faster rate than salaries, and the lending industry has tried to solve this problem by giving borrowers who are barely able to buy a home a huge number of mortgage options.
Most of these loans have interest rates that can change and require a minimum down payment. One of these, the option ARM, is the riskiest type of loan that has ever been made. Borrowers who are thinking about getting an option ARM should know that they could end up with a loan that is worth much more than the house it was used to buy and that they can't pay back. ARM is not for people who are easily scared.
So, what is an option ARM exactly?
A mortgage with an option ARM has an interest rate that changes over time and usually gives the borrower four different payment options each month. The first choice is based on an amortisation table for 30 years, and the second choice is based on an amortisation table for 15 years. These would be the payments for a 30-year mortgage with an adjustable rate and a 15-year mortgage with an adjustable rate. The third option is to pay only the interest that builds up during the month. This doesn't bring the loan balance down at all. The fourth option, the "minimum payment," is what makes this loan so dangerous. The first month's interest rate is used to figure out the minimum payment. This rate is usually a very low "teaser" rate that can be as low as 1%. Most borrowers with an option ARM choose to make the minimum monthly payment, which is where the trouble starts.
The interest rate on the loan can change, and it can change as often as every month.
If the borrower only makes the minimum payment, that isn't even enough to cover the interest on the loan for that month.
What comes next?
The interest that has built up but hasn't been paid is added to the loan's principal.
The principal can actually go up, and since interest is added to the principal, the amount of interest due will also go up.
Interest rates are close to all-time lows right now, but they will go up soon.
If a buyer keeps making only the minimum payments on an option-based ARM, the principal of the loan will grow over time.
We call this "negative amortisation."
Only bad things can happen when the amortisation is negative.
Under certain conditions in the loan agreement, the lender can make you refinance.
The buyer may not be able to pay back the loan, in which case he may have to "default."
And the lender could end up with a note for the house that is worth a lot more than the house itself.
The option adjustable-rate mortgage (ARM) is a loan that works best for investors and people who only plan to live in their home for a short time.
It's not a good choice for people who might use it to buy a bigger house than they can afford.
Sadly, that's how a lot of people who get this kind of loan describe themselves.
If you want to buy a house and are offered this type of loan, you should be very careful because it could leave you both broke and without a place to live.
