.Net Disasters!
The internet is a wonderful tool but it can be a source of problems to mortgage shoppers if they don’t really understand the process and the program(s) being offered. The following are two examples of potential pitfalls of internet mortgage shopping.
Pay Option ARM Amortization
A client has come to me to refinance his 3/6 Pay Option ARM. He found the program after shopping on the internet for a low rate two years ago. Pay option ARMs offer a payment selection each month: minimum payment, interest-only payment, full principal and interest payment, or 15-year payment. What most borrowers don’t understand is how these payment choices really work and what their impact is on the principal balance over the life of the loan.
If you make the full principal and interest payment or the 15-year payment, you are maximizing the full benefits of the lower interest rate you get with these type ARMs. However, if you make the minimum payment or the interest-only payment, there is potential risk. With the interest-only payment, you are not reducing the principal loan balance so at the end of the fixed-rate period (in this case, 3 years), you still owe the same amount as you did when you first closed on the loan. With the minimum payment, you’re probably not even covering the full interest amount each month, which is then tacked onto the principal balance. In effect, you are then paying interest on interest.
Essentially, it works like this. If you have a $250,000 principal balance and the minimum payment is $1100 but the full interest-only is $1295, the $195 difference is tacked on to your $250,000 each month you make the minimum payment.
For my client, the result is that after making minimum payments for the last two years, his original loan balance has increased by over $10,000.
This can create serious problems if you are in a position where you need to sell your property and appreciation hasn’t off-set this principal balance increase. Not to mention, you are now paying interest on interest charges.
Pay Option ARMs are great loans when the borrower fully understands how they work and maximizes their advantages while avoiding their disadvantages.
Next, Part II…..Payment Versus Program Focus.