Don't Fall for the Option-Payment Mortgage Trap

2. You may get whacked with a sharp increase in your monthly payment.

Option-payment mortgages allow negative amortization only for a specified period, typically five years, after which the loan payment will "recast," or be recalculated with full amortization.

For a borrower who has grown accustomed to making the lowest option-payment each month, this can lead to payment shock, as there is a sharp increase in the required payment. The new payment will be based on the increased loan balance and the interest rate, and the borrower will now have a traditional principal and interest loan payment. This new payment may well be more than the borrower could have afforded when the loan was originated.

3 Your best-laid plans could lead to foreclosure.

During the residential real estate boom, lenders and mortgage brokers would often push option-payment mortgages using the same argument they used to push ARMs. The pitch was that if you were only planning to own the house for a few years, this would be the best deal for you because you'd have lower payments now. Besides, you could always refinance to a fixed-rate or simply sell the property for a profit and walk away.

The expectation was that the borrower would build equity regardless of the loan features, because home prices would continue rising sharply. The triple whammy of low (or no) down payments, negative amortization and payment shock quickly led to financial disaster for many borrowers. In today's environment, many people who used option mortgages with low down payments to buy homes will find it impossible to sell their houses for a profit. With little or no equity in their homes, it may also be quite difficult to refinance and avoid foreclosure.

Since you really can't predict everything that will happen after you buy a home or refinance, you should resist the option-payment temptation. You're going to have to pay for the home, and hiding from doing so by using option payments is the surest way to experience payment shock and foreclosure. Your mortgage should be a simple instrument that helps you pay for a home. Anything as complicated as an option-payment mortgage spells doom.