Pick-a-Pay Loans Prove That The Lowest Monthly Payments Isn't Always The Best Deal

Posted by  on Jul 20, 2009

In a recent Wall Street Journal article, Option ARMs (or pick-a-pay loans) generated proportionally more loan delinquencies and foreclosures than sub-prime mortgages for the third straight month. As of April, California-based First American CoreLogic revealed data showing 36.9% of Option ARMs were at least 60 days past due, while almost 20% were already in foreclosure. While sub-prime mortgages were more prevalent, these Option ARMs still maintain a substantial position on many bank's balance sheets.

These Option ARM loans provided homeowners with a variety of monthly payment options, one of which allowed borrowers to pay below the amount of interest charges due. As a result, these loans were exposed to the possibility of negative amortization since loan balances could increase. Surprisingly, even homeowners with relatively good credit standings became attracted to these exotic loans and their artificially low monthly payments. Many attempted to take advantage of skyrocketing home prices, while keeping their investments at a minimum with the lowest monthly payment option. Unfortunately, as home prices eventually headed south, this risky investment quickly turned into one of the most dangerous loans available. In the meantime, government intervention has kept current mortgage rates for these loans relatively stable since so many are vulnerable to the adjustable rate indices.

Loans Still Vulnerable Even with Lowest Mortgage Rates in Years

And while those who hold these loans are most susceptible to negative equity and adjustable mortgage rates, almost everyone should consider the likely fate of these loans. Due to increasing mortgage balances and depreciating home values, many of these loans will inevitably recast causing serious issues in the near future. Even with the lowest mortgage rates in years, most of these homeowners will still face a 7.5% increase on their minimum monthly payment option because of the way these loans are structured. And when the loan finally recasts, many borrowers will be shocked by the fully amortized payment spread over the remaining years left in the loan.

As these loans continue to grow in size, speculators should be concerned with how many homeowners will be willing to pay for a home that is so grossly upside down on its mortgage. This is the true concern as it affects everyone within an arm's length distance of these ticking time bombs, and not just the borrowers who hold these loans.

Although these loans are quite rare nowadays, potential home buyers and existing homeowners should take this as a reminder that even the lowest monthly payment isn't always the best deal available.


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