High Risk Loans Are Often Misunderstood by Consumers

Option ARM and Interest-Only Mortgages should be offered less often, Feds say

In years past, the 30 year fixed-rate mortgage was the predominant lending product for those who wished to buy a home. People saved their money until they had a 20% down payment, and then prepared to pay for the next three decades on their houses. When interest rates reached double digits in the late 1970’s, lenders began aggressively pursuing other means of lending money for houses, and since then, the industry has offered a diverse array of lending products. It can be accurately said that there is now a mortgage product for just about anyone, regardless of their income or credit score.

But having a product for anyone does not mean that a particular product is good for everyone. In recent years, Federal regulators have been alarmed to see an extraordinary number of borrowers take out loans that are often viewed as potentially dangerous for the borrower. There are a number of different loans that qualify, but the ones that concern the Feds the most are the interest-only mortgage and the Option ARM. It seems that many people have taken out these types of mortgages without realizing the potential pitfalls of this type of lending arrangement. As such, regulators have urged lenders to exercise more caution when offering these loans and to make sure that borrowers have a thorough understanding of how they work.

The issues at hand are as follows -

Interest-only mortgage - With an interest-only mortgage, a borrower makes payments that are, in terms of repaying the principal, artificially low. For an agreed-upon period of time, such as three to five years, the amount that the borrower pays each month is equal only to that month’s accrual of mortgage. The payment does not include any principal. After the introductory period, the loan amounts increase in order to repay the principal in full over the remaining life of the mortgage. If the borrower has paid interest only for the first five years, he or she will see a huge jump in the size of the payment as the adjustment after five years will now include the principal, which now must be repaid over the remaining 25 years of the loan. This huge jump in the amount of the payment often catches borrowers off guard, and many who were not expecting the increase find themselves unable to make their monthly payments.

Option ARM - The same can be said of those with an Option ARM. This dangerous loan offers four types of payments each month. The cheapest payment option requires the borrower to pay even less than the interest that has accrued that month. Continued payment of this minimum amount over time can lead to a situation where the loan principal increases as interest accrues. Eventually, the amount owed can exceed the value of the property.

Regulators acknowledge that there is a time and a place for these types of loans, but urge lenders to be more careful in offering them in order that they be offered only to people who understand the dangers of taking out such a loan. No one wants a borrower to default on a mortgage because he or she didn’t understand that the payments would eventually increase.