Payment option mortgages became more popular as home prices rose and homeowners refinanced to withdraw equity from their homes. Unfortunately, most lenders failed to adequately explain how these loans worked. They also downplayed how easy it is to find yourself upside-down in this type of mortgage.
If you're confused by your payment option mortgage and concerned that you may be facing foreclosure, you can get help before you receive a notice from the bank. If you've already receive a notice of default, you do have options. First, you need to understand how this loan works, and then you can find the best solution for you.
Clear Facts About the Payment Option Mortgage
Payment option mortgages were created in 2002, but didn't become really popular until home prices reached their peak in 2005. Lenders who advertised these loans enticed borrowers with the flexibility of four monthly payment options:
- The full payment under an amortized 30-year loan
- The full payment under an amortized 15-year loan
- A full interest-only payment based on the current interest rate
- A minimum payment based on a much lower "teaser" rate.
Unfortunately, most lenders didn't clearly explain that choosing the last option results in negative amortization. This means that the unpaid interest from the minimum payment was added to the principal loan balance.
Unlike other adjustable rate mortgages, the interest rate on a payment option mortgage resets every quarter or every month. The loans are also "recast" after a set period of time, usually five years. When a loan is recast, the full payment is recalculated based on prevailing interest rates and the remaining term of the original loan. For example, a 30-year-mortgage is recast as a 25-year-mortgage after five years. Lenders did not tell borrowers that payments usually sharply increase every five years, especially if borrowers took advantage of the interest only or minimum payment options.
Most payment option mortgages are not due to be recast, but borrowers are now facing excessive loan-to-value ratios that also result in higher payments. Under the cap, the fully amortized principal and interest payment is due once the current loan balance surpasses 110-125% of the original loan balance. The cap may also apply if loan balance is 110-125% more than the current home value. Many borrowers are faced with that situation now.
Your Foreclosure Solutions
If you received notice from the bank that you've exceeded the negative amortization cap or are due to be recast, you're probably faced with much higher payments than you were promised when you received the loan. Some borrowers are able to cover the full payments, however the sharp increase is a challenge for many families. If you can't afford the new payments, you do have options that will prevent foreclosure.
Refinancing Your Mortgage: If you have good credit, you may be able to refinance your mortgage into a fixed-rate loan. Your payments will be higher, but you won't be subject to wildly fluctuating payments. If your home value is well below the amount you owe, you may have to make an additional down payment.
Modify Your Mortgage: If you can't refinance, your lender may be willing to modify your existing loan to make your payments more stable. Options include extending the term.
Sell Your Home: If you can't afford the new payments, you may be able to sell your home. In a declining market, it's unlikely that you'll sell the home for the full loan balance, but your lender may accept a short sale in order to avoid paying foreclosure fees. Your lender must approve the sale, so contact them before beginning a short sale.
Request a Forbearance: Forbearances are usually available for borrowers facing temporary hardship such as a job loss or serious illness. You should request one if you expect to be able to make the full payments once your situation improves.
File for Bankruptcy: Bankruptcy won't prevent foreclosure if you're unable to make the payments once you emerge from the process, but it may reduce your other debts so you can continue to pay your mortgage. It will also buy you time to sort out your finances. Remember that it will damage your credit, so pursue other options before filing for bankruptcy.
Offer a Deed-in-Lieu: Some lenders will accept the deed to the house in lieu of foreclosure. You will lose your home, but your credit report won't be tarnished by a foreclosure. Contact your lender to discuss this option rather than simply walking away from the house.
The best way to avoid foreclosure is to contact your lender the moment you realize you're in trouble. Don't wait for the notice of default or until you're behind in your payments. If you act now, you'll have more flexibility in find the right solution to your payment option mortgage.