We’ve Got a Pay Option ARM Mortgage That is Killing Us. – Bill

“Dear Steve,

My wife and I where pursuaded by a friend in the mortgage business about four years back to refinance into a pay option ARM in order to help us pay off some of our other debt and now this mortgage is killing us.

Our credit card debt is all but gone, however the mortgage payment has increased to the point where we have only been able to make the minimum payment and therefore along with the negative amortization and the decline in home values we now owe $225,000 dollars on a home that would now only appraise for around $180,000.

We have been trying to refinance the home for the better part of 3 years with our current lender, but where always told that we could not due to the negative equity.

Now they are offering to modify the loan, but not to a payment we can afford. They have been unwilling to reduce the amount of the mortgage to a reasonable level that would allow us to make the payments and keep the home. We are currently not behind on any payments, but continue to acquire negative equity. What can we do?


Dear Bill,

You have a right to be very concerned about this situation. There is a second wave of foreclosures that will happen over the next couple of years that involves people just like yourself in one of these option loans with adjustable rates.

As you know these loans let you decide which payment to make each month. Typically it is a choice between payment that would be equivalent to a 15 year amortization, a 30 year amortization, interest only or the smallest payment which is not enough to cover the interest so an amount gets added to the total loan balance to make up the difference. It certainly sounds like that is the amount you are paying and still struggling with.

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You have two issues here. The first is the loan. You are right, you do need to get yourself out of the loan and into a fixed rate mortgage. The second problem is that the home is now worth less in value than you owe so no mortgage lender is going to touch you.

There is no law that requires a mortgage lender to modify any mortgage so there is no leverage you can apply there.

In your case the lender has already made you a modification offer but you recognize that you can’t afford even that amount.

It seems to me that you’ve got one approach left, to fall behind on your mortgage payment. If you fall behind there is a small chance that your lender might see that you can no longer afford your mortgage and make you a better modification offer. But lenders don’t operate logically.

If that strategy does not work you’re probably headed to a foreclosure and a subsequent bankruptcy.

It is very unfortunate that Congress failed to pass legislation recently that would have allowed bankruptcy judges to have the power to modify mortgages. If they had that would have been a good option for you. And because this is your principal residence current bankruptcy law does not offer you any protection that I’m aware of. If this was a second home or vacation property, then your mortgage could be modified through bankruptcy.

Bottom Line: I’d love to give you some hope but the reality is that you’re probably screwed here. I think you’ll have either a move in your future after you lose the home to foreclosure or you might be tempted to fall for some of those mortgage loan modification propositions that require you to pay a fee upfront to work with your lender. But remember, the lender has already given you their answer.

If you do slip behind on the mortgage and it eventually leads to foreclosure you will probably follow up the foreclosure with a bankruptcy to discharge the residual debt you will owe from the house.

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You are going to have to break this negative equity situation one way or another or it will still lead to problems down the road. This situation is not going to get better by doing nothing.


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Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
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4 thoughts on “We’ve Got a Pay Option ARM Mortgage That is Killing Us. – Bill”

  1. I hear these stories all the time. They of course were persuaded, which is possible given Loan Officers were making as many as 5 points(IndyMac paid this in 06) on the back end of these loans. However, if you couldn’t even make the minimum payment, how could another loan be affordable?
    Option ARM’s should have low rates right now- their interest rate should reflect current rates.

    Usually someone just hears what they want to, in this case, the minimum payment. They know its a neg am payment, but figure they can just pay the 30 or 15 yr payments down the road. Then their income doesnt change, the neg am catches up with them, and they can blame the LO and ask the bank to bail them out. All the while we all support this behavior and take pity on these people.

    Anyways for anyone else considering an option ARM- read up on them first – here is a good site that breaks it down nice and simple:



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