Once again I find myself dealing with several clients who were sold Option ARMs (Adjustable Rate Mortgages), and had absolutely no idea how they worked until it was too late. The odd part for me was that all three of these people are professionals with some amount of either legal or accounting backgrounds. The other common thread was that all three felt they were entirely mislead about the way this product worked, or they never would have gotten into it. So I thought as a matter of public service it would be a good idea to get yet another warning out.

Option ARMs are completely without merit from a consumer standpoint 99.99% of the time. The primary reason they are sold is because they pay a substantially higher commission to the loan officer involved. That is because the bank/mortgage company is the only real winner with this kind of product. So if you are getting a mortgage and some loan officer is trying to sell you this kind of loan, you should turn and run right now. Do not look back and never speak to this loan officer again. He or she does not have your best interest in mind. In fact the only exception to this rule is if you came to them with the idea of doing a reverse mortgage to begin with. (It may be an acceptable substitute for a true reverse mortgage in certain circumstances). That’s it! There is not one single reason to select this product, in this market, for any other reason whatsoever. Period. So let’s look at the why.

The reason these are called Option ARMs is because when you get your statement each month, there will be at least three different payment options. The first option is the hook that is used to catch the unsuspecting consumer. It is usually calculated at some amazingly low rate like 1%-3%, depending on what type of Option ARM you are looking at. The reason I say it is calculated as a payment at 1%-3%, is because this gives the consumer the false impression that they are actually making a real payment at that low rate. Unfortunately that is first problem. The fact is it does not even come close to covering the interest portion of the payment, at the “REAL” interest rate they are being charged. The “REAL” rate is calculated by adding the index and margin together, as defined in the Note Payable. This “REAL” rate currently averages in excess of 8% at most mortgage companies. Option number two on your monthly statement is an “interest only” payment at the “REAL” rate, and the third option is the only real payment (principal and interest) at the “REAL” rate to be found. So what happens when I make just the payment suggested in option number one, you ask? Well, the bank calculates the difference between this phantom payment and the “interest only” payment in option number two. Then they add this amount back to the principal balance of the loan. So not only are you really paying at the 8%+ rate, but now you get to experience the joy of that rate compounding against you in the balance of your loan. So the first option is nothing more than a decoy, to tie you into a loan that is charging a “REAL” rate you would never have volunteered for. After all, 30 year fixed rates are already below 6% and can be arranged to include “interest only” payment features.

As if this wasn’t bad enough already, there are plenty of additional reasons to avoid this product. It adjusts monthly and has no effective interim cap on the amount of the adjustment to the “REAL” rate. And the lifetime ceiling is commonly set at 18%, so there is no comfort there either. The practical effect of this is that the consumer takes 100% of the risk related to rate fluctuations throughout the life of the loan. Oh and did I mention that there is usually a 1-3 year prepayment penalty? After all, once a bank has you duped into this kind of nightmare, you certainly can’t expect them to let you refinance out of it without 6 months of additional interest being charged can you? In fact, the commission to the loan officer involved is higher, the longer the prepayment penalty he or she sticks you with. A really sleazy loan officer can earn as much as triple the normal going commission in this way. Kind of makes you feel warm all over doesn’t it!

For honest advice from someone who really cares, call the professional. Dan Smith can be reached at 303-674-0201, or visit his web site at www.ColoradoHomeLoans.com and check out his complete consumer library today!