The 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.
