A Hidden Nightmare In Payment Options Loans

A past client calls you, totally in shock. She just received a letter from her mortgage company regarding changes to her payment option loan. It states that since her mortgage amount has increased due to negative amortization, she must now pay the fully-amortized payment.

In other words, the payment option loan is being stripped of its payment options! She took this loan out to have monthly payment flexibility; but now she’ll be saddled paying more than twice what she’s been paying. She tells you this new payment is financially impossible for her and ends the conversation with the question, “How can the mortgage company change rules midstream?”

THE RIGHTS OF THE LENDER TO CHANGE THE PAYMENT

The mortgage company can and does exercise changes to a mortgage payment during the life of the loan due to the language used in the mortgage papers your client signed at closing. This little-known payment change clause is currently affecting tens of thousands of homeowners nationwide and, unfortunately, is bound to breed a whole new rash of delinquent loans and foreclosures.

Here’s some background. The payment option mortgage is a type of mortgage (usually with an adjustable rate) that allows the borrower to choose one of four payments each month. For example, you can choose from a payment: 1) amortized for thirty-years (normal payment); 2) amortized for fifteen years (accelerated pay-off payment); 3) of interest only (no principal is paid); or 4) of less than interest- only (termed “minimum payment) where the shortfall/negative amortization is added back onto the principal balance.

Most payment option loans are for brief periods of three, five, or seven years in order to keep the principal balance from growing too large if only the minimum payment is made. While that sounded plausible in mortgage theory when these loans were birthed approximately five years ago, the application and subsequent outcome has morphed into a nightmare in the current mortgage environment.

LITTLE-KNOWN CLAUSE THAT BLINDSIDES CONSUMERS

A little-known clause in the documents for the payment option mortgage allows the lender to cease offering the monthly payment options for that loan once the principal balance reaches a certain high point, typically 110% of the original mortgage amount. Let’s say that your client’s original loan amount three years ago was $233,000 and she paid only the minimum payment each month since that time.

With the monthly payment shortfall/ negative amortization accruing over thirty-six months, she now owes $256,000, or 110% of the original loan. The lender’s position is that this extreme financial leverage could put her in a more likely position to lose her home to foreclosure. Moreover, the lender wants to protect their position against the borrower walking away from the loan due to low/ no equity.

The lender’s remedy is to require your client to stop the equity bleed and begin building equity in the property by paying the fully-amortizing, regular payment. In other words, the minimum payment of $871 on this loan now escalates to $1,797 per month…more than doubling her monthly principal and interest payment!

In a stance for self-protection, lenders across the country are mailing out payment increase letters by the thousands, giving little thought that a majority of borrowers choosing payment option mortgages did so because the fully-amortizing was financially out of reach. Unless a family takes on a second or third job or wins the lottery, this move will create additional insult to injury for homeowners in the already precarious market.

WAYS TO HELP YOUR CLIENT

There are several steps you can take to assist your client. First, recommend that she immediately call her mortgage servicer at the number listed on the notice she received. Ask what alternatives are available to her. For example, they might be willing to re-cast the loan at today’s current fixed-rate provided she qualified for that loan amount and provided full documentation (verification of income, debts,
and the like).

Since many payment option mortgages have fairly steep pre-payment penalties totaling thousands of dollars that would need to be paid as well. If re-casting the loan is not financially feasible, suggest that she negotiate with the loan servicer to at least reduce the full payment to interest-only. This is sometimes provided to a borrower who has a flawless mortgage payment record in an effort to at least keep the loan from growing in principal through negative amortization.

While it will save only a few hundred dollars a month in payments, that might make the critical difference of keeping the mortgage current or going into default. This latest coffin nail in the already precarious mortgage market is one more reason for consumers to understand each and every clause in the mortgage documents before they sign them and to request a viable worst-case scenario when any type of option or adjustment product is considered.

If your clients have a payment option mortgage, it may be in their best interest to get their financial house in order and move to a fixed-rate mortgage as quickly as possible.