I mentioned those pay-option ARM loans, and our guess that we're going to see a larger number of foreclosures soon. I glossed over how truly evil these loans are.
What happens with these pay-option ARM loans is you get a set of payments you can choose to make.
Guess which one most people chose to pay?
All is merry until the loan reaches a certain point: usually where they have added $10,000 onto the principal amount of their loan. Then the payment terms change, and the homeowner no longer has choices about what to pay, they MUST pay the full PITI amount. Suddenly they have to pay an amount that doubles or triples their current payment. How many families do you know who live comfortably, but paycheck to paycheck? Doubling the mortgage payment can throw a real bender into the budget.
You may be thinking that this is a scenario that is uncommon. Just so you know, in our local Southern California area (and Las Vegas, Arizona, New York, Florida, and many other places where real estate was booming) prices and loan amounts are such that the homeowner enjoys a reduced payment for only a few months before they have unknowingly added $10,000 to their loan balance. Then they can't refinance without paying $20,000 or more in prepayment penalties.
Applicants were frequently "sub-prime" candidates, meaning they have credit scores which would not secure them the best rates on a traditional mortgage. Frequently these applicants' credit scores were pulled down by debt: tens of thousands of dollars of debt on their credit cards, car loans, and more.
Add to the mix inflated property values, Brokers encouraging the subprime loan applicants to "take advantage of the increased value of your home, take out a larger loan so you can pay off the debt on your credit cards," and loose lending standards, and you have a financial mess resulting in thousands of naive people choosing these pay-option ARM loans, choosing the lowest payment, quicly adding the $10,000 to their principal balance, and having their payment soon double or triple. They can never quite catch up with the drastically increased payments, and end up losing their home.
It was a nasty cycle, but one that was profitable for loan officers and brokers for many years.
What happens with these pay-option ARM loans is you get a set of payments you can choose to make.
- You can choose to pay the full amount of Principal, Interest, Tax, and Insurance (PITI - like if you had a traditional 30 year loan). [Most money out of pocket each month.]
- You can choose to pay the Interest-only payment (where you're only paying interest on the loan, not paying down the principal balance you owe). [Lesser amount of money out of pocket each month.]
- Or you could choose to pay an optional, even lower amount, which is what made these loans special. This amount was significantly less than either of the two other payment choices. What the Broker glossed over, as they were selling you the loan, is the amount of principal and interest you didn't pay was added back onto the loan as principal. [Least out of money out of pocket each month.]
Guess which one most people chose to pay?
All is merry until the loan reaches a certain point: usually where they have added $10,000 onto the principal amount of their loan. Then the payment terms change, and the homeowner no longer has choices about what to pay, they MUST pay the full PITI amount. Suddenly they have to pay an amount that doubles or triples their current payment. How many families do you know who live comfortably, but paycheck to paycheck? Doubling the mortgage payment can throw a real bender into the budget.
You may be thinking that this is a scenario that is uncommon. Just so you know, in our local Southern California area (and Las Vegas, Arizona, New York, Florida, and many other places where real estate was booming) prices and loan amounts are such that the homeowner enjoys a reduced payment for only a few months before they have unknowingly added $10,000 to their loan balance. Then they can't refinance without paying $20,000 or more in prepayment penalties.
Applicants were frequently "sub-prime" candidates, meaning they have credit scores which would not secure them the best rates on a traditional mortgage. Frequently these applicants' credit scores were pulled down by debt: tens of thousands of dollars of debt on their credit cards, car loans, and more.
Add to the mix inflated property values, Brokers encouraging the subprime loan applicants to "take advantage of the increased value of your home, take out a larger loan so you can pay off the debt on your credit cards," and loose lending standards, and you have a financial mess resulting in thousands of naive people choosing these pay-option ARM loans, choosing the lowest payment, quicly adding the $10,000 to their principal balance, and having their payment soon double or triple. They can never quite catch up with the drastically increased payments, and end up losing their home.
It was a nasty cycle, but one that was profitable for loan officers and brokers for many years.
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