Payment-Options ARMs - Friend or Foe?(Adjustable Rate Mortgages)

Payment-option ARMs have garnered a ton of negative publicity in the consumer press because of the risk these instruments allegedly pose to consumers. Some firms, such as Chase Home Finance, refuse to originate POAs, citing not only the moral hazard but the fear that these instruments could be ticking time bombs.

So, is the POA loan the "Great Satan" of mortgage finance or just misunderstood? It depends on who you ask. Many lenders like the loan and some, including mega-thrift Golden West Financial, have been funding POAs for years without any adverse effects.

To better understand the POA issue let's first review the product. A payment-option loan is called exactly that because it offers the homeowner four different payment choices each month. The "option" that seems to worry consumer advocates the most is the "negative amortization" choice which allows the mortgagor to make the lowest monthly payment possible by creating an "accrued interest" debt that must be settled at some point in the future.

Certain lenders making POAs have told us (not for attribution) that a large majority of the their borrowers are choosing the neg-am option which means instead of building up equity in their new abodes, they're piling up debt. There may be nothing wrong (or bad) about taking on added debt as long as the mortgagor's job prospects are good or the value of the home keeps rising.

Then again, as we all know, eventually the piper must be paid, the chief question being will the piper be paid when the home is sold or refinanced or will the piper be paid when the house sells at a bankruptcy auction.

Mortgage lenders and servicers should indeed worry about POAs and take a prudent approach to underwriting the product. In the end, these fears about neg-am could prove to be overblown. But there is another issue at stake here, having to do with the lender and income recognition.

When a borrower with a POA chooses ...