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Negative Amortization Loans, Pay Option Arms

Lets talk about negative amortization loans. Often referred to as neg-am loans, pay option arms, choice option mortgages, option arms, mta, cofi and more. These programs are the ones that are frequently used in the leader advertising from mortgage companies today. They offer ridiculously low rates and payments to lure unsuspecting mortgage customers to pick up the phone.

Most people would never consider doing this type of loan due to the risk it represents. However, It is packaged and marketed in such a way that people living beyond their means or those that are in "too much house" find it attractive.

The Pitch: The advertisements are relentless, " $374 payment on a $175,000 mortgage", "rates as low as 1%"and "no closing cost" . The ads fail to mention that when you make those payments or take that rate you are actually adding money to your mortgage, and paying interest on it!

The no closing cost loans almost always come with a pre-payment penalty to ensure that the lender earns back the third party cost they have to pay out of pocket. The truth is, "there aint no free lunch".

The Program: What the lenders do is they establish an interest rate, usually one attached to a one month arm, (it will change monthly) let's call it 7%. For the sake of this example let's assume a $200,000 loan amount as well. Then they will establish a minimum payment rate, let's say 1.5%. Each month when your monthly statement arrives you will usually receive 4 payment options.

1. A minimum payment - A payment based on 1.5% on 200k is $690.00.
2. An interest only payment - A payment that multiplies the rate (7%) by the balance (200k) and divides by 12. This payment equals $1166
3. A fifteen year payment - A payment based on 15 years at 7% is $1797.
4. A Thirty year payment - A payment based on 7% at 30 years is $1330

If you make payment one, you will actually ADD $476 per month to your mortgage, almost 6k per year. If you make the second payment you will never pay your home off because you are only paying the interest on the loan. Payment 3 and 4 are based on a floating rate. Quite honestly, if you were going to make payment 3 or 4 you would probably be in a fixed rate loan to begin with.

So really, the only reason to obtain such a loan is to make payment 1 or 2. In some instances where housing prices are skyrocketing above the average salary this loan is a good option. For example, in orange county California where a 3 bedroom house cost up to and over a million dollars this makes sense. A teacher earning 60k per year doesn't have a chance to own a home in a decent neighborhood without a neg-am loan. However this the exception, not the rule.

Most average Americans enjoy modest appreciation of their homes and their salaries are in step with the housing market. Owning a home to add money to the mortgage not a good idea for 95% of mortgage holders. What happens is their spending will out-pace their earnings and they will seek lower mortgage payments to compensate the short fall. If your goal is debt consolidation you can simply refinance or add a second mortgage to accomplish your goals without puting your home at risk.

Mortgage companies know that most people will make the minimum payment as opposed to the other three. This sets the mortgage holder up for another refinance which usually includes a huge prepayment penalty. The pay option arm negative am loan is simply a bad mortgage program for 95% of all people. It is sold to mainstream America via low rates, small payments and low closing cost. Unless your income is below average and your home is appreciating at twice the National average you should not consider this type of mortgage program.