Ticking Time Bomb

So we left John and Mary with the imploding, soon to be exploding, mortgage. Things to remember about the Option ARM loan:

1. There is a minimum payment (which in this case would be based on a 2% amortized payment schedule - usually this loan has a 1% start rate, but because of the loan amount the bank required 2%)
2. The payment is based on LIBOR plus a margin (hypothetically 3% - since that is what my buddy who is a mortgage officer said they charged on ALL Option ARM loans)
3. The payment goes up 7.5% each year
4. The difference between the minimum payment and the interest only payment is added to the balance of the mortgage

Now these are very rough numbers, but here is their mortgage situation.

1st - $625,000 (5.8%)
2nd - $60,000 (8.25%)

Payment
1st - $3,020.83 (I/O)
2nd - $450.76
Taxes - $572.92 (1.1%)
Insurance - $97.51
DTI: 49.7%

John and Mary would not qualify for this home if it were not for the Option ARM loan. Because of the 2% start rate...they get a qualifying payment of $3,431.31 (PITI) which leaves them with a much more manageable DTI of 41.1%.

Here is a breakdown of the yearly payments:

Year - Payment (deferred interest) - DTI
2006 - $3,431.31 (8,528.56) - 41.1%
2007 - $3,604.57 (6,449.44) - 43.3%
2008 - $3,790.82 (4,218.04) - 45.5%
2009 - $3,991.04 (1,811.68) - 47.9%
2010 - $4,206.28 (-771.08) - 50.5%

After deferring the interest, John and Mary are looking at a mortgage amount of $645.236.64 on the 1st. Don't forget that the mortgage is amortized over 25 years...because the first 5 years are gone. So, here is the payment that is sitting out in front of them.

2011 - $5,199.93 - 62.4%

The second is slightly better because they have been paying this loan down. The balance is $56,451.09. The total owed on the house is $701,687.74.

The payment is already pushing what they can afford. They no longer eat out, go on vacation, etc... If they called their mortgage company they would know that the payment in 18 months is going to be way over what they can afford.

Options

They have 4 options sitting in front of them. The first is pretty simple. They can re-fi their home and hope to take advantage of the unbelievable interest rates. A commercial on the radio is boasting of incredible rates...4.5% to be exact. John and Mary have been faithful to make all of their payments on time...their credit rating is over 750...they are great candidates.

However, re-financing the 1st mortgage is going to give them a payment of $4,363.99 (DTI of 52.4%). The result is that their payment actually goes up $157.71 per month. They will get relief of $835.94 per month over the 2011 fully amortized payment. John and Mary can probably suck it up and cover the additional payment. Except, the home is worth $375,000.

The second option is they can try to modify their loan. They can take part in President Obama's plan to help homeowners and re-structure their debt.

The third option is they can sell their home. Unfortunately, the issue of the homes worth crops up and this appears to be a dead-end for John and Mary.

The last option is to "walk away". They can stop making payments all together. They can save their money and start their life over.

Options 2, 3, and 4 need further unpacking...check back for the next post!