Home Buying in Solana Beach>Question Details

Roberta Murp…, Real Estate Pro in San Diego, CA

Is an Option ARM ever a good product for a borrower?

Asked by Roberta Murphy CRS, GRI, San Diego, CA Sun May 13, 2007

We have seen many borrowers getting wiped out with these loans. Is there ever a time it is appropriate for a real estate purchase? The flipping market is history.

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I'd be wary of using the Option ARM for stated income or no doc borrowers, Roberta. It is a VERY powerful tool when appropriately used in a financial plan. Identifying an ability to repay this loan product is of paramount importance for it to work.
Web Reference: http://brian-brady.com
3 votes Thank Flag Link Mon May 14, 2007
When used as a tool in a financial plan. Leveraging to invest in a higher return investment (home equity is a horrible investment because it's illiquid and can go down) is a great arbitrage strategy. The trick is to find a mortgage advisor who actually understands financial planning
Web Reference: http://brian-brady.com
3 votes Thank Flag Link Sun May 13, 2007
Yes, but only specific borrowers with specific goals and timeframes and in specific markets. (you can tell this is going to be a long answer… grin…)

"Option ARM"s were called "NegAm"s before we lenders realized it was dumb to market the cons of the product... (The balance grows) Why not highlight the pros and market it as an "Option ARM" instead....?! (The borrower is given several payment options) In the end ALL loan are just financial tools, they are not good or bad. But just like any tool the user must be educated on how & when to use the tool. Give the hammer to a contractor and he can build a home. Give the same hammer to a baby and he can end up very injured.

Void of any marketing spin, it is simply a "deferred interest" loan that requires a good understanding of the product's potential risks and behavior over time.

If your client is being offered an Option ARM because that is the only way he can afford the payments and there is no reason to believe he/she will have a substantial increase in income/assets in the next 2+ years, then get a better loan officer if you care about developing your referral base. The real estate agent will always be linked in the buyer’s mind to the proper fit of the loan, regardless of whether or not the agent referred the loan person. Of course your job is to guide, advise, and protect the buyer in their mind – not just locate and negotiate. I have lots of people refinancing out of Option ARMs who talk about the agent and the loan officer with the same tone.

As long as the loan officer takes at least an hour describing how the product performs as compared to the buyer’s other options in relation to cash flow, dealing with the recast, any applicable prepayment penalty in dollars, and the accruing balance, then the following instances are situations when an Option ARM may be a good choice: (I draw pictures, use lots of easy to understand analogies, ask the borrower to paraphrase easily confused concepts, and finally ask them to sign disclosures that highlights the potential risks… )

• An Option ARM may be good for long term real estate investors (buy & hold philosophies) who purchase in a market that exhibits leading economic indicators for 2 or more future years of strong appreciation. (He can buy several appreciating homes “breaking even” on an Option ARM rather than 1 negative cash flow on a Fully Amortized or 1 breaking even on an Interest Only)

• An Option ARM may be good for short term real estate investors (flipper philosophies) who purchase in a market that is currently and strongly appreciating. (He can buy a fixer-upper and use all his cash to rehab it for a quick sale)

• An Option ARM may be good for a homeowner who cannot afford the home they want and has strong reason to believe that their income will substantially increase in the next couple of years, and they do not want to wait until that time to buy their home.

• An Option ARM may be good for a homeowner who has strong reason to believe that their assets will substantially increase in the next couple of years, intend to use those funds to pay down the balance and refinance into a more conservative loan at that time, and they do not want to wait until then to buy their home.

• An Option ARM may be good for a homeowner who has plenty of cash flow but is self employed (or an investor) but can earn a higher ROI in their other business dealings than the cost of money on the Option ARM.

For your buyers that do not fit one of the situations above or anything similar, but are being sold an Option ARM because they simply need a lower payment, my advice you would be to encourage the loan officer to look at getting them into an Interest Only loan and buying down the rate with seller closing costs if need be.

My favorite right now for a lot of borrowers is a 7/1 ARM, Interest Only for 10 years, No Prepayment Penalty, an ULTRA LOW 1.5% Margin (this directly impacts the rate if you hold the loan past 7 years), at 5.375% if your buyer pays a discount of 1.5%. This is a truly excellent and “safe” loan that goes to 100% (when we can find a 2nd that works for them) and delivers high client satisfaction and lots of referrals. It requires a 700 fico for Stated and 650 for Full Doc. It requires No Assets for either full doc or stated income... Awesome, true!!!?!!!
Web Reference: http://www.sdlendingco.com
0 votes Thank Flag Link Sun May 13, 2007
Other than flipping, option ARMs can be a good cash flow management tool if your income varies a lot and you typically get large once-a-year payouts (like a sales bonus, etc). The key is to make more than the minimum payment on a regular basis--at least the fully amortized amount--otherwise you're just begging for trouble.
0 votes Thank Flag Link Sun May 13, 2007
Yes, I can think of several example for option arms loans.

1 - Small Business owner and cash flow is very important for you
2 - Buying a home with build in Equity,
I have several Investors that use this method currently
0 votes Thank Flag Link Sun May 13, 2007
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