I’ve Been Paying On My Mortgage And My Balance Went Up!?

There are going to be plenty of surprised folks in the near future when they go to sell, refinance, or use some equity in their home and they find out that they’ve gone backwards. Some of my new clients have asked me, “How can it be that I made my $2000 monthly payment on time each month for over a year, and I now owe $15,000 more than when I started?” “I even got this great 1% interest rate,” they exclaim.

“When you got this loan, did your broker or lender mention the words ‘Option ARM’ or ‘MTA Option’,” I’ll ask them. I typically hear, “Uh…yeah…I think that sounds kinda familiar.”

Nine times out of ten, consumers will get hurt if they have various payment options. Payment options are made worse by being coupled with an adjustable rate mortgage (ARM). Very few borrowers have 1) sufficient understanding of “negative amortization” and, 2) the discipline to make the appropriate payment to avoid negative amortization.

Let me break down what I just said into a bit more detail:

The MTA Option ARM is, first of all, and adjustable rate mortgage. Lenders or brokers that sell this type of loan will certainly use “1% interest rate!” as a selling point. Unfortunately, this rate will not last. When the rate on this loan adjusts, it will be based on the monthly treasury average (MTA). Typically, there is a margin that will be added to the MTA (the actual margin on your loan should be disclosed in your loan’s note which you received at closing). Let’s say, for example, your MTA Option ARM carries a margin of 3.25. Let’s also assume that the monthly average yield on the treasury market is 5.25% when the rate is due to adjust; the new rate will be 5.25 + 3.25 = 8.5%.

The Option ARM gives the borrower payment options, hence the name. The three payment options are a normal principal and interest payment (PI), interest only (IO), or a third smaller amount that doesn’t even cover the interest charges. With the smallest payment option, the deferred interest is simply tacked onto the loan balance; this is called negative amortization. You now understand how people can make regular payments only to see their loan size increase; they’ve been making the smallest payment possible, so they can “afford” a larger home.

Now, the lender will not allow this increase in loan size to go on indefinitely. It wouldn’t make sense for them to assume the risk on a loan when the balance now far exceeds the value of the home. Therefore, once the loan amount reaches a certain percentage of the value of the home, the lender will require the borrower to begin making a normal PI payment. It is very possible that by this time the rate has adjusted from the 1% to 7.5%, 8%, or more. This rate adjustment will also severely impact the new payment. The borrower was used to paying, say, $800 per month. Now they are shocked to find out that they have to start paying $1,800 per month, and the balance on their loan has gone up $20,000.

In this case the people owe more than the house is worth, so they can’t sell it. They can’t afford the higher monthly payment. Maybe their credit was shaky to begin with, so the easiest this to do is to walk away from the home and let it go into foreclosure.

It is unfortunate that many people found themselves in these loans that can be quite confusing to consumers. Bad loans such as these are major contributors to the extreme number of foreclosures we are seeing now, and the problems in the subprime market.

I have never sold a single MTA Option ARM, and won’t (there are only a couple of instances in which one might make sense, but that is beyond the scope of this article). There are very few ethical, honest, high-quality mortgage professionals today. I am proud to be one of the few.