Today is the financial post in the Financial Money Trap Series of money traps I’ve personal fallen into and originally this was only to be a 2 post series but I felt this last post had to be said. In the first post I talked about a timeshare trap I fell into, and the second post talks about the credit card traps I’ve fallen into.
Today’s post is about a mortgage trap I fell into. This trap could have been much worse but I will explain what I did to prevent them from getting any worse than it really was.
The Option Arm Mortgage Trap And How It Works
Of all the different types of mortgages out there you defiantly need to watch out for this one. Now I’m not saying this is a bad mortgage. What I am saying is that this is a mortgage for only the most sophisticated people who are can take bigger risk and fully understand how this mortgage works.
The Option Arm Mortgage is unlike any other mortgage out there. All mortgages have a single payment and an interest rate. Sounds pretty simple but a Option Arm has an option of 4 different payments you can make on it.
- The first two payments are the 15 year payment, and a 30 year payment. Both of which are like paying on a 15 and 30 year loan except the interest rates are variable and can adjust on a monthly basis.
- The third payment option is an interest only payment. On this payment you are only paying the interest and no principle on the actual mortgage. This payment can adjust monthly as well.
- The fourth payment is called a minimum payment. This payment will actually be less than the interest payment. Though this payment does not usually adjust monthly. It usually can only adjust around 7.5% per year of the payment not the interest rate . So if you have a $500 minimum payment the next year the highest the loan could adjust to is $537.50.
How This Mortgage Was Designed To Work
When I first got the option arm mortgage I learned their was two different ways to use this loan.
- The way lenders prefer you to use this loan is for you to pay either the 30 year or 15 year payment like you normally would but if thing would happen to get tight and couldn’t make those two payments you could pay the interest only payment or if things were very tight you could make the minimum payment.
- The second way to use the option arm loan is to pay either the interest only payment or the minimum payment and save the difference you would be paying on your 30 year or 15 year payment aside into a separate savings account. Why do this? So you have easy liquidity on your money just in case you lost your job or had a dire emergency. Then after saving the extra cash and gaining a little interest on it after 30 years you can take that cash you have saved and pay off the mortgage in full.
The Problem With The Option Arm Mortgage
Sometimes things sound great in theory but in reality they just don’t work. In the case with the option arm mortgage it couldn’t be more true. Here’s the problems with this mortgage.
- You could pay the 30 year or 15 year payment option and only pay the minimum or interest only when you needed to but the issue I’ve seen here is that people will get stuck on paying the interest only or worse the minimum payment and eventually dig a hole so deep that they can’t even pay the 30 or 15 year payment.
- In the second way to pay off the mortgage you have to set up a savings account to set the money aside so you can keep your fingers off of it. However, the problem is that the mortgage lender only does mortgages. So this pretty much leaves you to figure out where to save the money but 9 times out of 10 you may spend all of the money before you save it.
- And last but not least the biggest problem is that the minimum payment on the option arm loan is a negative amortization payment. What this means is that you are paying less than the interest due and therefore add the difference between the interest only and minimum payment to your loan balance. Yes you heard me right your loan balance will go up. After 4 years of having this loan I ended up adding $4000 to my loan balance. What a shock this was.
Have You Been In This Mortgage Trap?
Again this mortgage is not for everyone but more important knowing all the risk involved. Have you ever been in this type of mortgage before? Leave a comment and let me know how it worked out for you.
This post was featured on the Carnival of Personal Finance by The Fraud Files Blog.
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