Option ARM Loans - Wow, never knew such an animal existed!

I

IrvineCitizen_IHB

New member
Okay, I'm green as green can be but I'm learning about all this stuff.



Another forumite gave me some info about Option ARM loans and I decided to research them. Okay, I more or less "wikipedia'd" them. Found a couple web sites with examples.



I didn't know these damn things existed!



So 600K and the first year you pay 1.25%. Then it goes up by current payment + max of 7.5% of that payment. So if your first-year payment at the 1.25% rate is X, your second year payment is X+(0.075*X). Well on a 600K loan your first year payment is like $1900. Your second year payment is $2050. That's DIRT CHEAP!



I had heard of Interest Only loans, and 2% teaser rates, etc etc etc. But these loans are FRIGHTENING! $1M loan for $3500. That's not too shabby!



Evidently there are millions of options and iterations of these loans. You can pay what you want to pay. Interest only this month? No problem. 30-year fixed this year? No problem.



I am dumming (sp?) this down obviously but these loans MUST have a very scary drawback somewhere. Obviously you don't want to be around in 3 years when that 7.5% compounds and interest rates go up, etc.



Are these the same as those Alt-A loans that everybody talks about taking out another 50% of mortgages?



Option ARM. That's a good one!
 
Welcome to the party. Be very afraid of how your neighbors got that lifestyle. They aren't keeping it once thier financing times out.



Seriously, you didn't know this was how all these properties were getting sold?
 
[quote author="IrvineCitizen" date=1243498128]Okay, I'm green as green can be but I'm learning about all this stuff.



Another forumite gave me some info about Option ARM loans and I decided to research them. Okay, I more or less "wikipedia'd" them. Found a couple web sites with examples.



I didn't know these damn things existed!



So 600K and the first year you pay 1.25%. Then it goes up by current payment + max of 7.5% of that payment. So if your first-year payment at the 1.25% rate is X, your second year payment is X+(0.075*X). Well on a 600K loan your first year payment is like $1900. Your second year payment is $2050. That's DIRT CHEAP!



I had heard of Interest Only loans, and 2% teaser rates, etc etc etc. But these loans are FRIGHTENING! $1M loan for $3500. That's not too shabby!



Evidently there are millions of options and iterations of these loans. You can pay what you want to pay. Interest only this month? No problem. 30-year fixed this year? No problem.



<strong>I am dumming (sp?) this down obviously but these loans MUST have a very scary drawback somewhere. Obviously you don't want to be around in 3 years when that 7.5% compounds and interest rates go up, etc.</strong>



Are these the same as those Alt-A loans that everybody talks about taking out another 50% of mortgages?



Option ARM. That's a good one!</blockquote>


And you are so far upside down that you can't refinance to that great fixed rate and consolidate all of your debt like you were told you would be able to do in two years. Welcome to the American Nightmare.
 
[quote author="no_vaseline" date=1243500060]Welcome to the party. Be very afraid of how your neighbors got that lifestyle. They aren't keeping it once thier financing times out.



Seriously, you didn't know this was how all these properties were getting sold?</blockquote>


Sorry, wasn't trying to come off as a smart -ass (dumb-ass?).



The way I thought it worked was:



Buy a house 10 years ago for 350K. It appreciates up to 700K in 5 years due to craziness.



Take out a 200K HELOC against the house and put 150K of that down on another 600K house and finance it at some teaser ARM of 3% for the first three years and then prime after that.



That house appreciates a couple hundred thousand in a couple years so you take out another HELOC for 200K and sell the first house and pull 100K out of that. Put that 300K down on this million dollar third house with some 3% teaser ARM.



Take another 150K HELOC out on that house. Buy two Range Rovers and a Porsche 911 with that HELOC money to park in front of your 1.2M dollar house.



Three years later the teaser rate is gone and your $3000 a month payment is now $4500 a month. You can't pay your property taxes, the HELOC payment is huge and there's no more house available as an ATM.



I had no idea about Option-ARMs. I thought the best you could do was maybe a 3 to 4% teaser rate on a traditional ARM.



But then again, I don't know much about this stuff.
 
Ha! We knew they were out there, but never looked at them as an option. Hubby's dad was telling us back in '06 that we could do this and not even need to put anything down in order to get into a house. The problem we saw was that an entry level house was $700K and we knew we could not afford that and weren't about to pay $450K for a darned 2bd condo.



Silly us for thinking about the principal. We just never understood the concept behind "you refi when it appreciates" because that didn't seem to resolve the problem of the principal. I am still appalled that people fell for this. At the time we had no idea that RE was going to crash, but we did get the sense that this whole option arm, refi later was a ponzi scheme because you couldn't just take on $700K in debt when you could only afford $450K and we looked at what we would were actually paying in price for what we were getting.



And this is really my point... we didn't have a clue that RE was a bubble and would crash, but common sense told us not to buy even though we wanted a home of our own. It never occurred to us that all the people buying couldn't actually afford what they were buying. We honestly didn't understand how first time buyers could get a start and figured everyone buying had all this money from the sale of their previous home. We really had no idea that people were using these loans like a ponzi scheme. It seems so obvious now that we know, but then we didn't. All we had was simple common sense that you buy what you can afford and what we could afford was a rip off.
 
[quote author="IrvineCitizen" date=1243503297][quote author="no_vaseline" date=1243500060]Welcome to the party. Be very afraid of how your neighbors got that lifestyle. They aren't keeping it once thier financing times out.



Seriously, you didn't know this was how all these properties were getting sold?</blockquote>


Sorry, wasn't trying to come off as a smart -ass (dumb-ass?).



The way I thought it worked was:



Buy a house 10 years ago for 350K. It appreciates up to 700K in 5 years due to craziness.



Take out a 200K HELOC against the house and put 150K of that down on another 600K house and finance it at some teaser ARM of 3% for the first three years and then prime after that.



That house appreciates a couple hundred thousand in a couple years so you take out another HELOC for 200K and sell the first house and pull 100K out of that. Put that 300K down on this million dollar third house with some 3% teaser ARM.



Take another 150K HELOC out on that house. Buy two Range Rovers and a Porsche 911 with that HELOC money to park in front of your 1.2M dollar house.



Three years later the teaser rate is gone and your $3000 a month payment is now $4500 a month. You can't pay your property taxes, the HELOC payment is huge and there's no more house available as an ATM.



I had no idea about Option-ARMs. I thought the best you could do was maybe a 3 to 4% teaser rate on a traditional ARM.



But then again, I don't know much about this stuff.</blockquote>


Your epiphany reveals that you now understand the mechanism that inflated and popped the housing bubble.
 
[quote author="IrvineRenter" date=1243503920][quote author="IrvineCitizen" date=1243503297][quote author="no_vaseline" date=1243500060]Welcome to the party.</blockquote>


Sorry, wasn't trying to come off as a smart -ass (dumb-ass?).



</blockquote>


Your epiphany reveals that you now understand the mechanism that inflated and popped the housing bubble.</blockquote>


Welcome to the dark side.



You weren't being a dumb/smart ass. Welcome to the party.



I concur with IR
 
So Irvine Citizen, through your discovery of the Option ARM. Have you discovered what happens when the value of the house goes DOWN and not UP?



What happens when the house appreciates so much that first time buyers can't even afford the Option ARM payment?
 
[quote author="24inIrvine" date=1243511840]So Irvine Citizen, through your discovery of the Option ARM. Have you discovered what happens when the value of the house goes DOWN and not UP?



What happens when the house appreciates so much that first time buyers can't even afford the Option ARM payment?</blockquote>


Do you mean depreciates? I'm not understanding the question.
 
[quote author="tmare" date=1243512033][quote author="24inIrvine" date=1243511840]So Irvine Citizen, through your discovery of the Option ARM. Have you discovered what happens when the value of the house goes DOWN and not UP?



What happens when the house appreciates so much that first time buyers can't even afford the Option ARM payment?</blockquote>


Do you mean depreciates? I'm not understanding the question.</blockquote>


For the second question? I was asking what happens when that 2/2 entry level condo that was 250k in 2000 and is now 650k in 2006 and that Option ARM payment is now unaffordable to that first time home buyer.
 
[quote author="24inIrvine" date=1243512272][quote author="tmare" date=1243512033][quote author="24inIrvine" date=1243511840]So Irvine Citizen, through your discovery of the Option ARM. Have you discovered what happens when the value of the house goes DOWN and not UP?



What happens when the house appreciates so much that first time buyers can't even afford the Option ARM payment?</blockquote>


Do you mean depreciates? I'm not understanding the question.</blockquote>


For the second question? I was asking what happens when that 2/2 entry level condo that was 250k in 2000 and is now 650k in 2006 and that Option ARM payment is now unaffordable to that first time home buyer.</blockquote>


Ok, maybe I'm being dense, but the two don't seem to have anything in common. The problem seems to be the person who got the ARM in 2006 for 650K and now cannot afford the payment because it's worth 450K (or so). I don't understand where the 250K in 2000 comes into play.
 
[quote author="24inIrvine" date=1243512272][quote author="tmare" date=1243512033][quote author="24inIrvine" date=1243511840]So Irvine Citizen, through your discovery of the Option ARM. Have you discovered what happens when the value of the house goes DOWN and not UP?



What happens when the house appreciates so much that first time buyers can't even afford the Option ARM payment?</blockquote>


Do you mean depreciates? I'm not understanding the question.</blockquote>


For the second question? I was asking what happens when that 2/2 entry level condo that was 250k in 2000 and is now 650k in 2006 and that Option ARM payment is now unaffordable to that first time home buyer.</blockquote>


The first time buyer will be able to buy it again at 200K - in 2011.
 
The 250k comes into play cause that 450k is still unaffordable to the person that would traditionally buy that 2/2. Which in my estimate, that buyer would most likely be a first time homebuyer right below the median income as it right below the median 3/2 house.



The reason this comes into play is the 450k not only is not affordable and takes out buyer, but the drop in prices also makes the Option ARM that the person used in 2006 impossible to refinance. Which leads to more defaults and more drops in prices.



And as No_Vas stated above, this comes full circle as they will soon be able to purchase it again at the affordable price. Maybe not as low as 200k, but somewhere close.



I probably screwed up explaining this, but thats one of the reasons I see prices going down for awhile. IR probably could write this much better. Actually he probably did in his book and I just screwed up what I learned from him :)
 
You all should read the blog more often. <a href="http://www.irvinehousingblog.com/blog/comments/mortgage-magma-the-coming-eruption-of-option-arms/">I did a great post, back in November 2007 (damn... it really has been that long?) on the mortgage magma explosion of the option ARMs</a>.
 
[quote author="graphrix" date=1243518156]You all should read the blog more often. <a href="http://www.irvinehousingblog.com/blog/comments/mortgage-magma-the-coming-eruption-of-option-arms/">I did a great post, back in November 2007 (damn... it really has been that long?) on the mortgage magma explosion of the option ARMs</a>.</blockquote>


Thanks for posting this. I hadn't read that entry before.



Now I'm a little more confused.....



So are the Option-ARM terms always variable? What I mean is that do they guarantee that you won't have a lousy payment for three years or can the example IrvineRenter gave in the blog happen?



He stated that the loan could actually get scary in just over two years as interest rates rise. Well, that's happening right now. So will Option-ARM payments start increasing for everybody right now?



I realize that every loan probably is different and has unique terms but I'm wondering if you could get in trouble in only a couple years in an Option-ARM.



Fascinating stuff! Thanks for the read!
 
I think they have different terms for when they are scheduled to reset the rate, but one thing that will trigger a reset is when your balance goes over a certain amount of the value of the home. I can't recall if it's 110%, 115% or 125%, but the values have dropped by over 25% in almost every city, so the option ARM's should already be resetting.
 
I found something that could explain it in bonehead terms for me.



If you make only the MINIMUM possible payment the difference between that payment and the fully amortized payment will be added to the principal. On their 500K example, if they paid the minimum $1800 payment another $1400 PER MONTH would be added to the principle.



When the principal hits that 110, 115 or 125% value the loan resets and your payment jumps to $4000 a month!



So it all depends on how little you pay. And if I was ignorant enough to get into an Option-ARM I'm certain that I wouldn't be the kind of person to kick in a few extra dollars a month towards reducing the principal.



Wow. Live and learn. I'll tell my twins about this in 20 years when it becomes en-vogue again and they become tempted.



Edited because I was too ignorant to use the proper form of "principal" in my original post.
 
[quote author="IrvineCitizen" date=1243550082]I found something that could explain it in bonehead terms for me.



If you make only the MINIMUM possible payment the difference between that payment and the fully amortized payment will be added to the principle. On their 500K example, if they paid the minimum $1800 payment another $1400 PER MONTH would be added to the principle.



When the principle hits that 110, 115 or 125% value the loan resets and your payment jumps to $4000 a month!



So it all depends on how little you pay. And if I was ignorant enough to get into an Option-ARM I'm certain that I wouldn't be the kind of person to kick in a few extra dollars a month towards reducing the principle.



Wow. Live and learn. I'll tell my twins about this in 20 years when it becomes en-vogue again and they become tempted.</blockquote>


When the LTV increases past the contracted limit on a specified date, the <strong>PAYMENT RECASTS</strong> to full amortization. It does not reset.

When the interest rate increases for whatever reason, the interest rate <strong>RESETS</strong>.

Two different animals, and the two can occur by themselves or in combination.
 
[quote author="stepping_up" date=1243548820]I think they have different terms for when they are scheduled to reset the rate, but one thing that will trigger a reset is when your balance goes over a certain amount of the value of the home. I can't recall if it's 110%, 115% or 125%, but the values have dropped by over 25% in almost every city, so the option ARM's should already be resetting.</blockquote>




From what I have learned, dropping market values do not affect the "recast". (reset is an interest rate reset, from teaser to market, and a different animal, usually spelled out in the initial loan docs, like a 7/1)



the 10%, etc above is from the initial loan value, and refers only to deferred P&I (neg-am), from the "100%" initial loan value (whether or not that '100%' was the total market value of the house, or 70% of the appraised value).



Historically these loans were used for people with wildly inconsistent incomes (like film industry people), who would put down a substantial DP. I read that prior to the 2000s, they were typically loans for 50%-70% of the appraised value.





(PS-could a REAL loan person correct any mistakes I made in my reading of the history?)
 
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