Low Interest Rate Mortgage - 1% - Is This Possible?

       If you have watched the TV lately, you probably have seen advertisements offering $200,000 mortgages for $750 a month. Is this even possible? Although this offer seems really great, it might seem to good to be true; it is! The payment for a mortgage this size by traditional methods is nearly double. So what exactly is this kind of loan anyway?

       It has a variety of names, the pick a payment loan, the payment miser but it is probably best known as the option arm. It is called the option arm because you have four payment options every month to choose from. There is a 30 year fixed payment, a 15 year fixed payment, an interest only payment, and a start rate payment (or minimum payment).

       You might ask, "What exactly is a start rate payment?" I am commonly asked by my customers, "Is this interest rate real, and what is this 1% interest rate? I have never heard of that type of payment before." Let me explain. Mortgage payments consist of two parts, the interest part and the principle part. The interest part is what you are paying the bank above the actual amount of money that you borrowed. The next part is called the principle payment. A traditional mortgage payment has both parts in it. The 1% loan program that I'm writing about has essentially three parts: a start rate payment or minimum payment, the interest payment, and the principle payment.

       These loans typically only allow you to borrow up to about 80% of your home value. They only allow this much of a loan balance because of their structure of repayment. Remember, I said that there is this start rate payment, or minimum payment. This payment is typically less than the interest payment. When this is the case, the difference in payment between the minimum payment and the interest payment is added to your mortgage loan balance. This is called negative amortization. The lender will allow you to do this until your loan balance goes up 25% from where it started. For example, if you originally took out a $200,000 mortgage then you could continue to pay your minimum amount until your loan balance got to $250,000. Once you reached this amount, the lender would then make you start paying back principle and interest. If you reached this point, your payment would go up considerably.

       An unethical lender may not disclose these facts to you about this mortgage program. They are very lucrative for loan officers and mortgage companies to sell. Lenders know that consumers in America, you and I included, are payment driven. Lenders know that homebuyers want the house so bad they will pretty much sign anything to get in. Show them a payment they can afford and it is an easy sale for a slick mortgage officer.

       Are these mortgages bad? They don't have to be. If they are used smartly they can offer tremendous leverage in buying real estate. They probably worked best in an appreciating market. I had a client who bought a home in the early 2000's. He bought it on an option arm mortgage. When the market went up he took cash out of his primary home to buy a rental property. As the market kept going up, he made money each month. The appreciation was rising faster than the negative amortization. So as long as he was out pacing the negative amortization with appreciation he was fine. My client's minimal investment to buy his first home became $200,000 in equity by the time he finished buying and renting out his rental property. He has since move out of the option arm loan to protect his equity position.

       If you are in an option arm now you may want to look at going to a fixed rate product. The other thing of late is that the indices for the option arm that determine your interest rate have been on the rise. This index is the same nature as the index on any ARM program. There is also the margin. The margin and the index are added together to give you your interest for this particular loan. The index most often used is the MTA or the monthly treasury average. This MTA has gone up considerably in the last few months. This only makes the negative amortization greater. This means that your equity is disappearing even faster than ever. The slick mortgage officer probably doesn't want you to know about this. Actually most loan officers that I know don't fully understand how they work but sell them anyway.

       As with any financial product or decision the more you can educate yourself, the better you will be served. The option arm, just like any financial product it is neither good nor bad. You either have the loan or the loan has you. Just make sure that you are on the right side of it. Otherwise it will run you over. I'm giving you serious advice, if you don't understand this product, don't do it. It won't get any easier once you are in it. Getting rid of it could be difficult if your equity has been eaten away. Do your research; interview your mortgage consultant carefully. You may want to talk to someone in your sphere to see if they have had any experience dealing with this type of product.