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by Tom Kelly, Inman News

House photoThe memory of a no-nonsense conversation, held more than a decade ago, hit home then and is vivid today.

“This probably would not be the loan for a person who planned on making just the minimum payment every month,” said the Washington Mutual senior loan consultant. “It’s a great program for borrowers who really might use the flexible payments, but if you stay with the minimum, you are absolutely going to owe more than you borrow.”

I thought about that meeting the other day when I read that WaMu had discontinued its option-ARM (adjustable-rate mortgage) loan program along with its Mortgage Plus loans — and laid off 1,100 more employees. Earlier this year, the bank had closed its home loan centers, sending potential residential mortgage applicants to its retail banking outlets.

The reason WaMu pulled the mortgage programs was the national scrutiny toward any negative-amortization loans. Negative amortization occurs when the monthly loan payment is less than the principal and interest needed to pay off the loan in a specific period of time. The difference is added to the loan amount, so that the borrower owes more than the amount initially borrowed.

Why, you ask, would you ever take out a loan where you owed more than you borrowed after a few years? In a perfect world, when you had all the money you needed when you needed it, you would never subscribe to such a deal.

But think about it will you have to refinance the house — or at least consider a home equity loan — to send the kids to college? Or put mom in an assisted living facility? We did both and the option ARM was a terrific vehicle for those financial challenges.

The Mortgage Plus loans offered built-in lines of credit while the option ARM gave borrowers more choices over monthly payments each month, thus providing an opportunity to “flip-flop” payments according to household cash flow. After the initial start period, customers could select among four payments plans each month during the life of the loan. Borrowers were never locked in to one specific payment or amount, leaving open the possibilities of pulling back during a money crunch or shelling out more after an unexpected windfall.

I’m all about options and variety. The more options, the better the chances of filling an individual need. While the intent of the loans was genuine and really attempted to give borrowers a solution for the different financial times of their lives, too many consumers became comfortable in the “minimum payment option” and quickly found they owed more than they had borrowed. Had they converted to a more accelerated payment schedule the negatives would have been “washed” by payments that covered more than principal and interest.

In addition, too many loan representatives did not do a thorough job of explaining the pitfalls of “staying minimum” for a significant period of time.
Let’s remember that three of the four payment options of the option ARM did not render negative amortization, yet the program got absolutely hammered because it dangled the carrot of low monthly payments to consumers. The menu:

Minimum Payment: Very low payment that leaves you more cash during lean months. However, the payment amount was not enough to cover the interest portion of the loan. The difference would be added to your original loan amount.

Interest-Only Payment: Payment still is low, yet you pay only the interest portion and any deferred interest that may have accrued. While you do not reduce the original loan amount, you do not “go backwards” or owe more than you borrowed.

Regular Payment: This is a common, 30-year, fixed-rate loan payment. When you choose this option, you pay all the interest and principal needed to pay off your loan on time.

Accelerated Payment: This schedule would pay off your loan after 15 years. The payment is higher, yet you save substantial interest dollars while gaining equity faster.

More than 15 years ago, WaMu was the first local lender to introduce a program that blended installment debt and a home mortgage secured by a first deed of trust. Like all programs, “Buyer’s Choice” had pluses and minuses. The good news was that it was a genuine attempt to wrap credit-card, high-interest debt into the lower rates brought by first mortgages.

The problem was that it confused not only consumers, but also the loan officers trying to explain it. It evolved into Mortgage Plus.

The option ARM was more flexible and useful. It was available for homeowners and investors, but some loan officers — many of them loan brokers not affiliated with WaMu — still didn’t get it or want to spend the time to explain it.

That’s why I was thankful for the upfront conversation about our loan more than a decade ago. I was advised of the consequences of minimum payments and steered clear of them unless absolutely necessary. Other borrowers did not make that choice, but they did have other options.

To get even more valuable advice from Tom, visit his Second Home Center. What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.

Copyright 2008 Tom Kelly

Click here for 11 Deadly Mistakes When Applying for a Mortgage.

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