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Payment Pig

Written by Posted On Friday, 18 March 2005 00:00

Okay, it's my turn. I don't like these things and I never did, no matter what they called them. What are they? Neg-am loans, that's what. Er, pardon me, I mean to politically correct say "Payment Option ARMs." Sheesh. What next?

For the life of me, and I know that I'm a guilty party, why lenders gave electricity to this Frankenstein is beyond me. The name has been changed from the more sinister "Negative Amortization" moniker to the Barbie-like Payment Option Arm. How sweet. A payment coming up? Aw shucks, it's just an option hon'. I'll tell you how these things work but first I'll tell you why they're being resurrected.

Lenders can freak out pretty easily when they see their pipelines shrink when compared to the previous year. Heck, they can freak when their loan volumes decline on a month-to-month basis. So what do lenders do to increase loan originations? They find a new product and market the dickens out of it. I just googled "payment option arm" and came up with 810,000 results and 10 paid-placement ads. And when one lender finds a new product then the other lenders must follow or else they can be perceived as not having as many loan choices as the next guy. That's why they do it. Loan production slows down, refinances almost disappear so let's do something, anything to get volume back up.

Are loan volumes down compared to other years? Yes, they are. But compared to what? Last year? The year before? 2004 was one of the best years ever for loan volume. The biggest was in 2003. And for 2005 the Mortgage Bankers Association of America is forecasting another solid year.

What about interest rates, aren't they up? Again, yes, but compared to what? You can still get a 30-year fixed rate under 5 1/2 percent, and you can count on your left hand how many years that has happened. But lenders get worried and they think up new stuff. That's where the Payment Option ARM comes in.

The "Payment Option" is a mortgage that gives you a choice of which amount you'd like to pay. Not a bad deal, right? I'd like to have the option of making a different payment every now and then (I have a 15 year fixed). Here's the drill. Each month you'll get a statement with up to 4 choices of payments. 1: The minimum payment which can last for a year with a cap of 5% every year, 2: An interest only option, 3: A fully amortized payment and, 4: a fully amortized 15 yr payment. There are variations to this theme but this is a common example.

If you only make the minimum monthly payment (sometimes as low as 1%) and not a fully indexed one (the index plus the margin) the difference between the two can be added back to your original loan balance. While "normal" loans are fully amortized over a pre-set term so that the mortgage is eventually paid off, loans can "negatively" amortize under Payment Option programs, actually increasing the principal balance rather than decreasing it.

I've heard all the hype, "But David, this gives the consumer more choices than before" or "But David, the consumer can increase their buying power" blah, blah, blah. All I know is that Neg-Am loans have little use in this business and in my recommendation should only be taken by those who truly understand the impact of the product. And barely, if that. Spinning a Neg-Am loan into increasing your buying power doesn't do much for me. There's not enough lipstick for that Payment Option Pig.

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