Pay-Option Borrowers Go Low by Lew Sichelman
Here's another indication that some home buyers and refinancers may be playing a dangerous game of mortgage roulette: Of the four choices available to those who have taken payment option adjustable rate mortgages, the one selected most often by customers of one of the country's largest mortgage companies is the absolute minimum. More than half the payments received in February and March by this lender, which provided these percentages on the condition of anonymity, were the lowest acceptable based on the 1 percent start rate. And about 4-5 percent more of the payments went for the interest-only option, meaning they choose not to pay anything toward outstanding balances. The rest of those borrowers with payment-option adjustables paid their full due over either a 15 or 30-year payment schedule. It's difficult, if not impossible, to draw any solid conclusions from this breakdown. Investment-savvy borrowers could be paying as little as possible and using their funds to better advantage elsewhere, for example. But if borrowers are paying the minimum because they were just scraping by and hoping that rising housing values will float their boats, they could be in for a rude awakening. If appreciation isn't as great as hoped, minimum-pay borrowers could end up owing more than their places are worth. That's because even though pay-option ARMs adjust on a monthly basis, the first dozen payments are at the initial start rate. Consequently, payments two through 12 may not be large enough to cover what you owe in principal and interest. And if that's the case, the difference is added to your loan's balance. It's a phenomenon called "negative amortization," or deferred interest, and it occurs when the mortgage payment is less than the interest due, which causes your balance to increase rather than decrease.What's more, there's a limit on how much the payment can increase over a year's time, so it's possible you'll be going backwards in the following year as well. The cap is in place as a consumer protection to prevent borrowers from being hit with a larger payment increase than they can afford. Typically, the cap on these sorts of loan products is 7.5 percent. But if you still owe more in principal and interest after your reset amount hits the cap, you'll have neg-am during the second year and your outstanding balance will increase again. The value of the property may well go up at a faster clip than the loan's balance. But eventually, appreciation is going to slow. Values could even slip a bit, depending on whether the market was over-heated to start with. And if that's the case, folks who have been betting the ranch could find themselves owing more than they borrowed.. Anyone considering a payment-option ARM, or an interest-only mortgage, needs to take a hard look at their reasons. If it's because they can't afford the house any other way, it's probably best to take a pass, especially at this late stage in the housing rally. Otherwise, you could find out too late that the boat has sailed without you. | 
