The Wrong Mortgage – A Hidden Time Bomb

Tick. Tick. Tick. Is your mortgage a hidden time bomb, carrying the potential to wreak financial devastation upon you? If you chose the wrong mortgage, you could be in for an unexpected surprise.

Many people, enticed by the lure of low monthly payments, chose a complex mortgage called an option ARM and when all is said and done it may end up costing them an arm… and a leg.

Option ARM mortgages give you the flexibility of four payment options each month:

1) A minimum payment, calculated based on a below market interest rate.

2) An interest only payment.

3) A payment based on a 30 year fully amortized loan.

4) A payment based on a 15 year fully amortized loan.

These payment amounts are recalculated each month, depending on what you did the prior months. For example, if you make a payment based on option 3 or 4, some of your payment will be applied to the principal of the loan. Next month, the interest only option (2) will be slightly less, as it will be recalculated based on a lower outstanding balance.

Unfortunately, most people with option ARM mortgages only look at payment option 1. They may not know that the difference between the current market interest rate, and the below market rate, is being tacked on to the principal balance of their mortgage each month. This is something called negative amortization. It means each year they are going deeper and deeper into debt.

It also means that as early two and a half years into such a mortgage they could hit a “triggering event” causing their required mortgage payment to increase substantially – in some cases it could even double.

What can you do if you have such a mortgage? First, find out where you stand. Do you owe more now than when you took out the mortgage? When exactly will your payments increase? Can you afford the increase in monthly payment?

Then carefully examine your options. Can you refinance to a fixed rate now, avoiding future increases? Is downsizing an option?

The more time you have to plan for the explosion, the better off you will be.

Option ARM mortgages are not all bad. They are complicated tools that offer a tremendous amount of flexibility. However, like many financial tools, they get misused. If you don’t understand how the tool works, either take the time to learn more, or decide not to use it.

All too often these mortgages are used to allow people to temporarily afford a house that would have been beyond their financial means. Sure, it’s nice for awhile… but what happens when the bomb goes off?