Getting Rid Of An Option Loan

If you currently have an option loan, also known as an exotic loan and want to get out of it, there are some serious issues to address.

In case you aren’t familiar, an option loan is a new type of mortgage created four or five years ago, where the borrower has four (4) different options to pay.

1. Minimum payment. This is always LESS than even the interest amount.

2. Full interest payment.

3. 30 year amortized payment

4. 15 year amortized payment.

The minimum payment was calculated usually on an interest rate of 3% which is why the minimum payment is almost ALWAYS LESS than the actual interest charged. The unpaid interest on these loans adds to the principal balance until the mortgage reaches 115% of what the original loan was. Then the loan starts a much higher monthly payment rate that is usually based on a 30 year amortized loan. I reviewed one situation where the payment was going to readjust from $2002.00 per month to $4950.00 per month, a pretty hefty increase!

These loans are variable rate loans and most have adjusted to an interest rate of 8 to 8.5%. Because of their attractiveness in cash flow in a market where prices were rapidly accelerating, lots of borrowers thought the appreciation on the property would more than offset any increases in their loan balance.

The market has since halted its rapid appreciation and if possible borrowers should get out of these loans. It is still possible to refinance your property at an interest rate of about 6.6%, or even lower.

BEWARE…and check your paperwork. Most of these loans contained a prepayment penalty of at least one year and quite often three years. The prepayment penalty, by law, cannot exceed six months interest on 80% of your loan balance. To ascertain your prepayment penalty, look at your “note” that you signed when you borrowed the money. That document will tell you what your prepayment penalty is and for how long the prepayment clause is in effect.

The next calculation that has to be addressed is whether it is more cost effective to refinance now at a “known” interest rate that is lower than you are currently paying and pay the huge prepayment penalty, or continue your existing loan at the higher rate until the time period of the prepayment has elapsed.

Remember, even if the new loan is allowing the lender to roll the prepayment penalty into your new loan, you are still paying this because you have a reduced equity in the property by whatever amount your costs are for the new loan. Some people get caught up in the concept that because they do not write a check, they didn’t pay it.

All of these calculations should be done with careful consideration. Other questions arise such as:

1. How long do you plan on keeping the property? If it is a short period of time, the costs of a refinance would not be worth it.

2. Do you have the ability to handle a sizable jump in your monthly payment when the payment recasting comes about?

3. Is there something in your future that you feel you might be able to pay off the loan with your own funds? Folks on commission sales can frequently do this. These loans worked well for high paid commission employees since they usually make a sizable income but the income comes in at irregular times.

DO NOT ALLOW YOURSELF TO WAIT UNTIL THE PAYMENT IS GOING TO RECAST WTIHOUT HAVING A PLAN.

THE ONLY PEOPLE THAT LOSE MONEY IN REAL ESTATE ARE ONES THAT DO NOT BUILD IN CONTINGENCY PLANS AND PREPARE FOR A WORST CASE SCENARIO.

MAKE 100% CERTAIN YOU WILL NOT BE IN THE POSITION TO HAVE TO “SELL” YOUR PROPERTY BECAUSE OF ONE OF THESE OPTION LOANS.

One of the worst things you can do with your portfolio is to get yourself into the situation of having to be a seller. This precludes you from being able to take advantage of the market. Do your homework now or work with someone you trust that can advise you.

The Optimum point is to be a buyer and take advantage of some seller that didn’t plan like you did!