How Toxic is your Mortgage? (Part 2)
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The first, as I discussed above, is because they get more interest on an option ARM. Look at the couple from Wisconsin. They ended up with a higher mortgage balance at a higher rate. Both of those items mean more money for the bank in interest. Take that and multiply by the millions of option ARMs written in the past few years and you’ll see why the banks pay mortgage brokers a higher commission to sell these products.
The second reason gets into accounting terms, but bear with me. Basically, even if you don’t pay the full amount every month the bank still gets to claim the full interest amount as revenue for financial statement purposes. It’s a quirk of accounting regulations that require banks to record loans on the “effective interest rate” method. This method is how you traditionally pay for a mortgage or any other loan. You take the remaining balance and multiply it by the interest rate. That’s the interest for the month. The rest of the payment reduces the principal of the loan, which is the starting point next month.
On an option ARM you are not even paying the interest, but the bank still claims it as “deferred interest”. How much deferred interest is out there? Golden West Financial, which was just purchased, had $754.5 million in deferred interest revenue in the twelve months ending June 30th. That’s $754.5 million of cash it did not collect, but was able to claim the payments anyway. Washington Mutual had $427 million in deferred revenue in the twelve months ending June 30th. Countrywide Financial, the largest mortgage lender in the country, had $294.8 million (all amounts in the article).
So, given all that is an option ARM right for you? It actually could be. If you are someone that lives on commission or a bonus system where you have a lot of money coming in one or two months and less the rest of the year, you could make the minimum payments and then make a big payment when the commission or bonus comes in. It’s basically the same argument as an interest only loan, but the payments are smaller if you keep up with making the big payment. Otherwise, stay the hell away.
I wonder what it will take for the Feds to step in. I really think that people are being taken advantage of in some of these cases because they are not financially literate. While that is the fault of the people taking out the mortgages, I really, truly believe that others should not take advantage of that to make money. I’ve posted on this many times and that is why I slag on H&R Block so much. They pray on people that they know don’t know any better.