You've got to pay more on your option ARM

Blue house on tax bill

If you have an option ARM and you've only been making the minimum payments for the past few years, you're headed for trouble.

At some point, perhaps in just a matter of months, you'll be forced to pay more -- a lot more. Perhaps twice as much as you've been paying.

You need to postpone that day of reckoning as long as possible, especially if you can't refinance or sell, by paying a little more now.

You also need to know exactly what you'll be facing when you hit your debt cap, or your first recast, and your option ARM suddenly becomes a no-option ARM.

Here's the danger you're in:

These kinds of adjustable-rate mortgages have proven themselves to be one of the most deceptive and costly home loans ever sold.

Mortgage brokers aggressively promoted their low monthly payments, allowing borrowers to squeeze into bigger, more lavish homes than they'd ever qualify to buy with a traditional fixed-rate mortgage.

But the "minimum payment" brokers emphasized when selling the loan doesn't even cover the monthly interest charge.

The difference between what you're paying and the interest you owe is being added to your balance.

You're literally falling further into debt with every check you write.

After five years, most option ARMs reach what's called the first recast. That requires you to start paying the full interest charge and to begin paying down the principal.

It's not unusual for payments to double.

But borrowers can be required to begin making what's called fully amortized payments on their loan before the five years are up.

Option ARMs have a debt cap -- usually called a balance cap, negative amortization ceiling or limit -- that will allow you to add only 10% to 15% to what you originally borrowed.

Homeowners who make nothing but the minimum payment often reach that cap in the third or fourth year of their loan.

The only way to keep below that limit is to write a bigger check that covers all of the monthly interest so your debt doesn't grow and trigger fully amortized payments until you reach the first recast.

Here's an example of how traumatic that can be: Let's say a homeowner used a typical option ARM to borrow $300,000 with initial minimum payments of $1,000 a month.

The interest rate began resetting after the first month (or maybe the first three or six months, depending on the terms). By the third year, the minimum payment has risen to $1,155.

That's still affordable, right? But by making just the minimum payment, that homeowner has been adding about $700 a month to his or her debt. So about three-and-a-half years into the loan, the homeowner now owes $330,000 and hits the debt cap.

The bank or mortgage company servicing the loan instantly raises the minimum payment to a shocking $2,300 a month.

The homeowner could have remained below the debt cap if he or she had just made the "interest-only" payments on the loan a few months earlier. That would have covered all of the monthly interest charge and stopped adding debt to the loan.

That move would have cost about $1,700 a month -- $600 more than the original minimum payment but $600 less than a fully amortized payment.

Many borrowers know little or nothing about their debt cap or recast clause because their mortgage brokers often said little or nothing about these things.

They preferred to tell customers that their home would appreciate more quickly than their loan balance, allowing them to sell or refinance long before any of that came into play.

Sure, a homeowner might owe $325,000 on a house that only cost $300,000 a couple of years earlier. But with housing prices going up and up and up, it would be worth $350,000 by then, creating $25,000 in equity for the owner despite the increased debt.

Unfortunately, that's not how things worked out. Home prices are now falling in most cities, and many borrowers with option ARMs have piled up more debt than their property is worth.

They owe $325,000 on a house that is now worth only $290,000, putting them $35,000 in the hole.

In lending lingo, they're upside-down on their mortgage, making it impossible to sell or refinance if they don't have enough cash to make up the difference.

Of course, the housing market will turn around over the next couple of years. Homes will begin to sell more briskly. Prices will start to rise, and some borrowers will regain at least a little equity in their homes.

But to get there, you need to buy some time and avoid hitting your debt cap before the first recast.

"People are going to have to realize that we are in a situation with housing and the economy where they have to go back to basics and make an effort to pay their debts down," says Richard Call, vice president for housing at Consumer Credit Counseling Services of Central Ohio in Columbus, Ohio.

If you're in danger of reaching your credit limit and you can't afford anything other than the minimum monthly payment, you need to ask your lender to restructure you loan before you default and face foreclosure.

Negotiating new terms with your bank or mortgage company is a long and arduous process. You'll need professional help to save your home.

We recommend a member of the National Foundation for Credit Counseling, the nation's biggest and oldest credit-counseling organization. Its 120 agencies abide by a set of professional and ethical standards that have served many individuals and families very well over the past 50 years.

Here's where to find an NFCC member near you.

The fees will be modest and their experienced credit counselors, who negotiate debt reduction and repayment plans every day, will be able to help you figure out affordable options for your option ARM.

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