There’s a new type of Option ARM on the market called a “hybrid”, and I’m finding that 80 percent of the loan officers who are calling to get help with using Mortgage Coach to display this loan are confused by that terminology. If the loan officer is confused, how are they able to properly educate the borrowers? A very scary thought.
First, an explanation:
The name is fitting. Essentially, this loan is a hybrid between your traditional hybrid ARM (i.e., 3/1,5/1 or 7/1 ARM) and a negatively amortizing ARM. The Hybrid Option ARM mixes some components of each type together.
Here’s how they work. You have an initial fixed rate period for 3, 5, or 7 years. This rate does not change and is priced off the lender’s rate sheet. Calculating the payment portion of the loan is where it can get confusing. Typically, you take the initial fixed rate for 5 years — let’s use 7.75% for our example — and subtract 3%, then calculate what the interest-only payment would be to determine the payment amount. So in this scenario, 7.75% minus 3% would result in a 4.75% interest-only calculation.
Others use a less confusing approach to determining the payment, such as the more traditional 1% pay rate. Either way, it is important to realize that either method is only relevant to what the dollar amount of payment is. The actual rates used to determine the payment have no bearing on the interest charged on the loan. Each investor words this part of the equation differently, which contributes to the confusion. But no matter how you slice it, the only thing that process determines is the actual dollar payment amount.
The minimum payment can be made for up to the term of the initial fixed rate period, or a maximum loan balance pre-determined by the investor guidelines (typically 110-120% of the original loan amount) and does NOT increase annually like traditional Neg Am loans do. At the conclusion of the fixed rate period or maximum loan balance, the loan recasts and becomes a monthly ARM. There are no caps to how the rate can adjust at this time. There is a Life Cap, which is typically 10-11%.
Now here is my opinion:
I believe that this loan is, for the most part, a good mix of two really popular loans. You get the security of a fixed rate and fixed payment. Another key function is that the deferred interest amount is predictable. Using Mortgage Coach, I can plug in the fixed rate and payment and know exactly what month the loan is going to hit the recast point. With this knowledge, I can reassure the customer that we will be reviewing their situation each year during the annual reviews to make sure they are on track; but at the very least, I will schedule a call 12 months before their recast date so we can get the paperwork started to assure that the client won’t face the payment shock sometimes associated with the recasting of the payment at the maximum loan balance.
The question of suitability continues to be a factor in placing customers in this type of loan. There are still some of the typical risks associated with it, i.e.:
- if a client misses payments, it adversely affects their credit;
- if they don’t save the difference in monthly payment between a traditional amortized loan and the hybrid option ARM in a side account they are never going to achieve their freedom point; and/or
- if the housing market slows down or decreases and there is little or no equity available to qualify for refinancing when the initial fixed-rate period is up or the maximum loan balance is reached.
Therefore, clients could be faced with a payment 80-120% higher.
My biggest complaint about this loan is the method with which the payment is calculated by some investors. Typical Option ARMs are confusing enough to customers and, frighteningly, to loan officers, as well. The method described above of taking the start rate minus 3% and an interest only payment — what is that to the untrained mind? How can you include interest only in the method to determine a payment that is less than interest only? A word comes to mind that I think sums it up well: oxymoron. Defined by Webster’s Dictionary, oxymoron means “a combination of contradictory or incongruous words”.
The bottom line: Before you sell any loan option, make sure you thoroughly understand it and can easily explain it. To ensure that you did your job properly, ask your customer if they have any questions. Watch their facial expressions and listen carefully to what they say and how they say it, even if they don’t ask any questions. Remember, it’s your responsibility to help them make the right loan decision.
One of our quality partners, American Brokers Conduit, is selling hybrid option ARMs. To learn more about it, go to: https://www.abconduit.com/scripts/cgiip.exe/products.html?HitID=6 and use their product advisor to create scenarios for your client.
To learn more about Option ARMs in general, I highly recommend reading our report “Demystifying the Negative Amortization Adjustable Rate Mortgage”.
To present Option ARMs well and to properly illustrate the recasting point, I recommend using the Total Cost Analysis report in the Mortgage Coach.
Read more about Recast Points and Recast Point Reviews: http://davesavage.typepad.com/my_weblog/2006/10/recast_point_re.html
Read more about Freedom Points and Freedom Point Reviews: ttp://davesavage.typepad.com/my_weblog/2006/10/helping_homeown.html
Mortgage Coach power user Scott Yonehiro tapped into collection agencies as a valuable referral partner and earned an extra $90,000 in commissions in 60 days. Using an introductory letter with a Debt Free Analysis, Scott showed collections agency managers how they could improve their collection rate through the use of his services. 