Fixed Rate vs. Adjustable Rate vs. Pay Option Arm

I’m sure the question “Why should I get an Adjustable Rate Mortgage when I can get a 30 year fixed rate at XX interest rate?” has been asked about a zillion times ever since the two types of mortgage were pitted against each other.

Of course, no matter what anyone ever says or does, there will always be advantages and disadvantages on both sides.

One HUGE advantage the ARM has is all the different sub-products that come under that category.  For instance the 3/1 ARM and 5/1 ARM, just to name a couple.   The fixed rate does not have these sub-products.   Traditionally speaking, you have 3 basic fixed rate products: 15 year, 20 year, 30 year.

(I’m sure some will say there are others, but let’s just keep this to a traditionally speaking level)

Then along comes this Pay Option Arm thing that totally throws a big monkey wrench in the “Fixed Rate vs. ARM” argument.

Why do I say this?  The simple answer is because this product totally takes away one of the biggest arguments people have against the ARM, “I don’t know how much my monthly payment will go up or down.  I don’t like the uncertainty of the ARM payment concept.”  You see, with the POA, the payment can be figure exactly TO THE PENNY (worst case scenario), for the next 5 years and with some products up to 10 years.  So the guess work is now out of the equation.

Now, with the POA a whole new debate comes up, the one about Deferred Interest (sometimes referred to as Negative Amortization).   I won’t get into a lot of details here, but Deferred Interest, if understood properly, can be utilized to be a HUGE advantage to the borrower.  In a nutshell, Deferred Interest gives the financial leverage advantage back to the borrower without sacrificing payment uncertainty.

It is totally the borrowers CHOICE to have Negative Amortization.   If the borrower chooses to do this, then other financial aspects of his/her life should be benefited.   Unfortunately, because of the way the POA is sometime explained to the borrower, this is not the case.

It is our job, as mortgage professionals, to make sure the borrower gets the correct information about the POA.  This next statement is one most brokers have a hard time with, so I’ll say it loud and clear…

Unless you are licensed to do so, YOU CANNOT TELL ANY BORROWERS WHAT DO TO WITH THEIR MONEY!  WE ARE NOT FINANCIAL PLANNERS.  DO NOT GIVE FINANCIAL ADVICE! 

Our job as brokers is to make sure our borrowers fully understand the type of MORTGAGE product and program we sell them, not give them financial advice.

Again, some brokers will debate that with me, but unless they are properly licensed to do so, there is no debate…period!

Once you realize this, you can develop a good relationship with someone who IS properly licensed and both of you can pass referrals back and forth.  This isn’t rocket science folks.

The reason I bring all this up is because lately I’ve had several borrowers come to me saying they got this POA deal a few years ago and they weren’t told about the Deferred Interest stuff.  Most of these folks have a POA tied to the LIBOR index.  If you look at the charts, you can see that the LIBOR has increased dramatically in the last few years.   Don’t get me wrong, I’m not knocking the index, I’m disappointed in the brokers that sold the borrowers that mortgage product without explaining the ups and downs of the product.   It has now put a lot of pressure on the brokers that do understand the product (and indexes) to “fix” the mentality of the borrowers that have a misunderstanding of how beneficial the POA actually is.  

Which brings us right back to the question “Why should I get an Adjustable Rate Mortgage when I can get a 30 year fixed rate at XX interest rate?”  The best answer I can come up with is, “It depends on how you want to utilize your mortgage and what best fits your situation.”