Strong ARM-ed Out of a Home

Posted on February 13 By MLP Blog

It was just what the mortgage doctor ordered, or so Renee Schwengel thought. What it turned into was a financial nightmare that could cost her family its home.

To free up a little cash every month, Schwengel and her husband were looking to lower the monthly mortgage payment on the four-bedroom, Aurora, Co., home they shared with their two children.

The couple had been in an interest-only loan paying a mortgage of $1,600 each month.

They heard about a loan with low interest rates on the radio and decided to check it out. She said they got a new loan through Altus Home Loans, but the company went out of business several months later.

And the Schwengels soon found out that their new mortgage, an Option ARM, was not what they thought they were getting.

  “It sounded pretty good. It never was mentioned that it was an Option ARM,” Schwengel explained. “All he said is that it would be like 1 percent the first year, 2 percent the second year, and the third year we would have to refinance ’cause the payment doubles.”

An Option ARM is an adjustable rate mortgage that gives consumers a variety of payment options, with an adjustable interest rate. Option ARM loans are designed to give consumers a lower monthly payment, but the payments usually do not cover the interest. Interest that is not paid off is then added to the the principal of the loan.

Borrowers are offered options on how large a payment they will make — they can choose interest-only payments or a minimum payment that is usually less than the interest-only payment.

With so many variables, Option ARMs can be risky for people who don’t fully understand their possible escalators, particularly if they choose the lowest monthly payments. And, like the Schwengels, some borrowers believe their loan companies offered them Option ARMs without fully explaining the potential pitfalls.

Realizing the Option ARM Mistake

By the time the Schwengels’ first payment rolled around, Renee Schwengel said she knew it was the wrong financial remedy. Her mortgage payments were lowered by roughly $900, but now she is paying an even bigger price.

“Of course it’s not 1, 2, 3 percent. It’s 8.375 percent,” says Schwengel. “Every time I make a $626.29 payment — I usually go $700 — my principal goes negative $796.42 every month,” explained the 42-year-old.

Schwengel said there’s no easy way out. She said she would have to pay more than $8,000 in penalties to get out of the loan.

“They’re very dangerous,” said John Marcell, president of Better Mortgage Brokers, Inc. “Unless the broker sits down and explains in depth what the pitfalls can be with an Option ARM, those people are going to find themselves in financial difficulties in a very short period of time.”

Schwengel said she fears she may lose her home because of her Option ARM loan. She’s not alone.

Lawyer Jeffrey Berns started running commercials about the loans on local radio stations around California on Jan. 8, looking for people who felt they were dishonestly directed into Option ARMs. He said he has received thousands of calls in response. Now Berns’s law firm, along with the firm Rose, Klein, and Marias, plan to file a class action lawsuit for clients who they believe were unfairly guided into Option ARM loans.

“The disclosures that are in these documents are deceptive,” says Berns. “There’s a recast provision in these loans that they fail to disclose,” Berns added.

“We have over a thousand people now that we’ve actually sent paperwork out to, to now get their loan documents. So we started reviewing all of them. Not one of them tells you anything different,” said Berns.

“Every single one of them, from all of the major lenders — from Washington Mutual, Downey Savings, Countrywide, Chevy Chase Bank, GMAC — all of the major lenders, we have examples in every one of those people who will tell you the exact same story of how they were told about this loan.”

Berns said he estimates that he will have about 25,000 clients when he is ready to file suit.

A Good Fit for Some, Financial Fiasco for Others

Consumers are attracted to the Option ARM loans because they offer flexibility. Experts say they are ideal for a salesman or actor who may have a fluctuating income. On the slow months, they would have the option of paying the low payment. When income picks up, they can afford to make the bigger payments.

Marcell said he has had clients that have successfully used Option ARM loans.

“They were being able to borrow money at a very low interest rate and make substantially larger payments than were prescribed.” says Marcell.

In a press release, the Federal Reserve Board said the Option ARMs also allow home buyers to qualify for mortgages that they normally wouldn’t qualify for under traditional loans.

The loans provide consumers with the option of paying low monthly payments. If the consumers keep making only the lower payment, the interest that is not being paid is actually tacked on to the principal, which may lead to negative amortization — meaning the balance on a loan would actually grow.

Since 2003, Option ARM loans have shown a steady increase in popularity. In 2003, they accounted for roughly 0.5 percent of all loans. In 2006, they accounted for 13 percent of loans through September. California, Nevada, Hawaii, Florida and Washington state all led the national average in Option ARM loans, according to First American Loan Performance.

Let the Borrower Beware

Lenders say they provide clear disclosures when they administer Option ARM loans.

“We believe that there is no substitute for an informed borrower,” Washington Mutual’s Timothy McGarry told ABC News in an e-mail.

“We make detailed disclosures to customers to ensure an understanding of the payment options at the inception of the loan and potential adjustments throughout the life of the loan.”

Other lenders agreed.

“The Option ARM is not right for everyone,” Jumana Bauwens said in an e-mail on behalf of Countrywide.

“Countrywide takes steps to inform borrowers about the features and potential risks associated with these mortgages.”

With the booming popularity of Option ARM loans and other so-called “exotic” loans, the Federal Reserve recently announced new guidelines that require lenders to inform borrowers of their highest possible monthly rate. Lenders must also mention the risks involved when advertising them.

The Federal Reserve also wrote a consumer-friendly brochure highlighting the terms and risks involved in nontraditional mortgage loans, which include interest-only loans.

As for Renee Schwengel, she said she has tried to refinance, but the deal wasn’t affordable. Until she figures out another option, she said she’ll take it day by day, dollar by dollar.

“I make the payment every month hoping that some how I can make more of a payment so I can get by another month,” says Schwengel.

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