The Option ARM Loan - Situations When it is Recommended

Last issue, I went through the mechanics of how the
Option ARM loan worked. The fact that it allows for low
introductory interest rates and payments creates the
possibility that the borrower may defer interest and owe
more later than they originally borrowed.

When these loans were originally offered, the lenders
would limit them to no higher than 75%-80% of the
value of the property. The idea, of course, was that if
the borrower made payments in a manner that let the
deferred interest accrue, that the loan would never
"grow" to be higher than the value of the property.

Over the past several years, and prior to the pullbacks
created by the mortgage turmoil about five months ago,
the lenders got more aggressive and expanded their
underwriting guidelines to accept more risk.

It was not uncommon for the lenders to offer these loans
up to 90% of value, or to couple the first loan up to 80%
with a second loan of 20%, allowing the borrower to
finance 100% of the value of the property.

Any prudent person could see that if property values
did not continue to climb, that this type of financing
package would create problems. It would not take
much for the loan balances to be higher than the value
of the property, and when that happens the willingness
of the borrower to continue making payments wanes.

So, when property values stopped increasing, and in fact
started to decline, the riskiness inherent in these financing
packages was finally exposed.

The headlines focused on the sub-prime loans, those that
were made to borrowers with low credit scores, but still
allowed for high loan balances in relation to the value of
the property.

But the more extreme Option ARM packages were also
destined to create problems for the lenders.

And now Option ARM loans are painted with the brush
that they are "predatory" or put borrowers in a position
that the lenders knew they couldn't sustain. As the
lenders revert back to more prudent lending standards,
there is a place for borrowers to consider this financing
tool as part of their options.

There is a place for this loan for both short-term and
long-term strategies, depending on the goal of the
borrower.

It is an effective tool for investors, who are primarily
concerned about cash flow from the property, especially
amid the uncertainty of tenant turnover, unexpected
expenses and prolonged vacancies. The ability for
an owner to begin with low payments and know
exactly how much they will increase each year is
very valuable in these situations. Of course, the
owner must have sufficient equity in their property so
that as they make the decision to make the minimum
payment and have their loan balance increase, it all
fits into their plan for the property.

It is also a loan that may work for seniors, who are
equity rich, but cash-strapped. They can take out
the loan, have very low payments and by making
the minimum payments, they can borrow from the
equity in their home on a monthly basis. This
plan also gives them some security of a nest-egg
which can be used as a sinking fund to supplement
their income to make the payments.

For those that have a short-term strategy, they
can use the loan to keep monthly expenses low,
knowing that they will never be "hurt" by loan balance
increases for the time that they will own the property.

And, there are times that a borrower wants to buy
their new home before having their existing loan
completely sold. They need a substantial amount
of the equity from their home in order to provide the
down payment for the new home. The Option ARM
can be a way to take cash out of the home, keep
their payments as low as possible, and close
escrow on the new home.

As you can see, the suitable use of this mortgage
is not a "one size fits all" approach. Those mortgage
lenders that pushed this to every borrower regardless
of individual circumstances were irresponsible and
not keeping their clients best interests in mind.

The media reporting on the mortgage difficulties that
we are sorting out right now do not understand the
nuances of the mortgage business. It is important
that when you want to survey your mortgage options
that you meet with a professional who can help you
find the right mortgage product to meet your needs.