Pay Option Loans

Here's the stat of the month," writes Outstanding Investment's Justice Litle.

"From 8 out of 1,000 - to 1 in 3."

The statistic Justice is referring to has to do with another 'creative financing' opportunity - pay option loans. In 2003, only about 8 out of every 1,000 people buying a home or refinancing a mortgage in California got a pay option loan - and this year, even as the real estate market is showing signs of wear and tear, 1 in 3 loan applicants chose this option.

And with the pay option loan, homeowners own a little less of their house as time passes.

Take Will Hertzberg, of Corona, California for example. As he so eloquently put it to the LA Times, "I am rather screwed."

The Times continues, "Like hundreds of thousands of other homeowners around the state, Hertzberg has a mortgage that lets him choose how much he pays each month.

"Like many of them, he always chooses to pay as little as possible.

"For the moment, this allows the 56-year-old Hertzberg to continue living in his tract home despite being only marginally employed. But his debt is swelling, and his mortgage company controls his fate."

And, interestingly, homeowners like Hertzberg control the fate of the housing market - and, some would argue, the overall health of the economy. Since these borrowers generally take the cheapest option every month, the borrower is betting the housing market will be better in a few years than it is today. If the house goes up in value, it will be possible to refinance and the day of reckoning can be put off once again.

"But the day of reckoning is arriving early," writes the Times. "By paying the minimum, Hertzberg has increased the size of his loan in a little over a year from $320,000 to $332,616. His lender, Calabasas-based Countrywide Financial Corp., recently sent him a letter warning that when his loan hits 115% of its original size he'll run out of credit with the company.

"That will happen in about two years if he continues to take the smallest payment option. Then his minimum payment will automatically go up 150%, to $2,848 a month.

"'If I could afford that,' he said, 'I wouldn't have needed this loan in the first place.'"

"'I'm waiting for a 100-year loan,' he said. 'My heirs can worry about paying it off.'"

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