graphrix_IHB
New member
<p>First I will start with a little history on option ARMs and then I will get into how they work. If all you want to know is how they work go ahead skip the history.</p>
<p>When I first started in the business I worked for a small mortgage shop and at that time only WAMU, Downey Savings, World Savings and other smaller banks offered option ARMs. Since we were so small we only had access to Downey and World Savings and we wouldn't have been able to get approved with WAMU because we weren't big enough. We would use Downey for the most part because they had almost the same product and rates as WAMU and World was more an "ALT-A" lender. When I moved on to working for the builder I gained access to WAMU because they were much larger. </p>
<p>Sometime in 2004 is when Countrywide rolled out with the option ARM to compete with their largest competitor WAMU. Several other lenders began to follow like Greenpoint, IndyMac and Impac. This gets excerbated by the fact that many other lenders had correspondent relationships with these lenders like No Red Tape and Express Capital could do these loans. Coutrywide and Bear Stearns were the two largest buyers of this loan. Bear Stearns decided that not only would they buy them but they opened up their own wholesale division to get the loans directly from the brokers. They could easily undercut their competition now because they didn't have to pay fees to the wholesale lender on top of the broker fees. They were the first to my knowledge of offer this loan on an 80/20 100% financing term. They also offered stated income with the option for 100% financing but the rates and fees were so high any lender with half a cow's brain would know that it didn't make sense. I don't know how many ouy there had less than half a cow's brain but probably more than I think.</p>
<p>Now in my opinion the main problem is that there is a serious lack of understanding on how this loan works. To give access to the likes of Quick Loan Funding and Optima funding promoting the fact that it pays a 3% rebate with a three year prepay but still keeping the start rate at 1% is what ruined them. When Impac got this loan the rep came into our office and tried to sell us on that same idea. I had to explain to her how it works and that the underlying rate was so high that it would recast before the three year prepay was up. She was pretty clueless and I don't think that she got it. Oh well my 401K didn't have Impac stock.</p>
<p>Now I will get into how they work. For an easy example I will use a $625k house with a $500k loan. I will use the 1 month option based on the MTA index. The <a href="http://mortgage-x.com/general/indexes/mta.asp">MTA index</a> is the 12 month moving average of the 1 year CMT treasury. So it follows the 1 year CMT but since it is averaged it lags when rates jump or down.</p>
<p>The reason they are called option ARMs is that you have the option to make different payments each month. The first being the start rate and in the hey day this was 1% and it was a fully amortized payment in the sense that the 1% isn't interest only but it does not mean that your principle is being reduced by paying it in fact it may not cover all the interest. The next would be the interest only payment, 30yr fully amortized payment and a 15yr fully amortized payment.</p>
<p>To qualify for this loan you would take the MTA index plus the margin and in the hey day it was the interest only rate that would be used. You would not be qualified by the 1% rate and is probably one of the biggest myths of this loan. The margin would vary by risk and by how much YSP the loan officer was making or screwing you with. A normal margin would be 2.65% and if you called Quick Loan Funding it would be 3.75%. As you can tell from the link above when interest rates were at the all time low your rate could have been as low as 4% making it really easy to qualify on an interest only payment of $1667.</p>
<p>The first month is a 1% fully amortized payment then after that the 1% is the minimum and the real underlying rate changes according the MTA index and the margin. The margin is fixed at an example of 2.65%. In the second month say in 2005 when the MTA was at 1.5% the bill will come and the minimum payment will be $1608. The rate for the other options would be the 1.5% index plus the margin of 2.65% rounded up to 4.25% and would be I/O $1770, 30yr $2460 and the 15yr $3761. As you can see the minimum payment doesn't even cover the interest and gets tacked on to your loan balance making your loan balance $500,162. The 1% minimum is fixed for the first year and adjusts yearly after that by 7.5% of the minimum payment. So take the $1608 minimum payment and multiply it by 7.5% = $120.60 add it to the minimum and the new payment is $1728.</p>
<p>Sounds like a pretty good deal when your home is appreciating faster than the deferred interest and rates are at historic lows. But rates rose and home prices are flat or even falling from 2005. This how the problems start and you can see for yourself with <a href="http://mortgage-x.com/calculators/pay_option_arm.asp">this calculator</a>. If the first payment was due January 2005 and only the minimum payments were made the loan balance would be nearly $537k today. If the value of the home is unchanged at $625k you are stuck with 86% loan to value of your home. With the tighter guidelines on LTV it would be very difficult to refinance right now and even more so if the value of the home dropped. If rates kept rising in May of 2008 your minimum payment would be $1998 a month. But come June you will have reached 110% of your original loan balance and the loan will recast and now you will have to make a fully amortized payment of $4350 on the current balance of $550k. If rates kept rising your payment would continue to go up and you would hit your rate cap of 9.95% in 2011 and have a payment $4934 for the life of the loan. If you kept the loan you would have paid over $1.1mil in interest on top of the $500k principle.</p>
<p>Next up will be when the margin is 3.75% and you have a three year prepayment penalty. </p>
<p>When I first started in the business I worked for a small mortgage shop and at that time only WAMU, Downey Savings, World Savings and other smaller banks offered option ARMs. Since we were so small we only had access to Downey and World Savings and we wouldn't have been able to get approved with WAMU because we weren't big enough. We would use Downey for the most part because they had almost the same product and rates as WAMU and World was more an "ALT-A" lender. When I moved on to working for the builder I gained access to WAMU because they were much larger. </p>
<p>Sometime in 2004 is when Countrywide rolled out with the option ARM to compete with their largest competitor WAMU. Several other lenders began to follow like Greenpoint, IndyMac and Impac. This gets excerbated by the fact that many other lenders had correspondent relationships with these lenders like No Red Tape and Express Capital could do these loans. Coutrywide and Bear Stearns were the two largest buyers of this loan. Bear Stearns decided that not only would they buy them but they opened up their own wholesale division to get the loans directly from the brokers. They could easily undercut their competition now because they didn't have to pay fees to the wholesale lender on top of the broker fees. They were the first to my knowledge of offer this loan on an 80/20 100% financing term. They also offered stated income with the option for 100% financing but the rates and fees were so high any lender with half a cow's brain would know that it didn't make sense. I don't know how many ouy there had less than half a cow's brain but probably more than I think.</p>
<p>Now in my opinion the main problem is that there is a serious lack of understanding on how this loan works. To give access to the likes of Quick Loan Funding and Optima funding promoting the fact that it pays a 3% rebate with a three year prepay but still keeping the start rate at 1% is what ruined them. When Impac got this loan the rep came into our office and tried to sell us on that same idea. I had to explain to her how it works and that the underlying rate was so high that it would recast before the three year prepay was up. She was pretty clueless and I don't think that she got it. Oh well my 401K didn't have Impac stock.</p>
<p>Now I will get into how they work. For an easy example I will use a $625k house with a $500k loan. I will use the 1 month option based on the MTA index. The <a href="http://mortgage-x.com/general/indexes/mta.asp">MTA index</a> is the 12 month moving average of the 1 year CMT treasury. So it follows the 1 year CMT but since it is averaged it lags when rates jump or down.</p>
<p>The reason they are called option ARMs is that you have the option to make different payments each month. The first being the start rate and in the hey day this was 1% and it was a fully amortized payment in the sense that the 1% isn't interest only but it does not mean that your principle is being reduced by paying it in fact it may not cover all the interest. The next would be the interest only payment, 30yr fully amortized payment and a 15yr fully amortized payment.</p>
<p>To qualify for this loan you would take the MTA index plus the margin and in the hey day it was the interest only rate that would be used. You would not be qualified by the 1% rate and is probably one of the biggest myths of this loan. The margin would vary by risk and by how much YSP the loan officer was making or screwing you with. A normal margin would be 2.65% and if you called Quick Loan Funding it would be 3.75%. As you can tell from the link above when interest rates were at the all time low your rate could have been as low as 4% making it really easy to qualify on an interest only payment of $1667.</p>
<p>The first month is a 1% fully amortized payment then after that the 1% is the minimum and the real underlying rate changes according the MTA index and the margin. The margin is fixed at an example of 2.65%. In the second month say in 2005 when the MTA was at 1.5% the bill will come and the minimum payment will be $1608. The rate for the other options would be the 1.5% index plus the margin of 2.65% rounded up to 4.25% and would be I/O $1770, 30yr $2460 and the 15yr $3761. As you can see the minimum payment doesn't even cover the interest and gets tacked on to your loan balance making your loan balance $500,162. The 1% minimum is fixed for the first year and adjusts yearly after that by 7.5% of the minimum payment. So take the $1608 minimum payment and multiply it by 7.5% = $120.60 add it to the minimum and the new payment is $1728.</p>
<p>Sounds like a pretty good deal when your home is appreciating faster than the deferred interest and rates are at historic lows. But rates rose and home prices are flat or even falling from 2005. This how the problems start and you can see for yourself with <a href="http://mortgage-x.com/calculators/pay_option_arm.asp">this calculator</a>. If the first payment was due January 2005 and only the minimum payments were made the loan balance would be nearly $537k today. If the value of the home is unchanged at $625k you are stuck with 86% loan to value of your home. With the tighter guidelines on LTV it would be very difficult to refinance right now and even more so if the value of the home dropped. If rates kept rising in May of 2008 your minimum payment would be $1998 a month. But come June you will have reached 110% of your original loan balance and the loan will recast and now you will have to make a fully amortized payment of $4350 on the current balance of $550k. If rates kept rising your payment would continue to go up and you would hit your rate cap of 9.95% in 2011 and have a payment $4934 for the life of the loan. If you kept the loan you would have paid over $1.1mil in interest on top of the $500k principle.</p>
<p>Next up will be when the margin is 3.75% and you have a three year prepayment penalty. </p>
