"Option" mortgages to explode, officials warn

[FarCenter]

WASHINGTON (Reuters) - The federal government and states are girding themselves for the next foreclosure crisis in the country's housing downturn: payment option adjustable rate mortgages that are beginning to reset.

Option-ARMs are now considered among the riskiest offered during the recent housing boom and have left many borrowers owing more than their homes are worth. These "underwater" mortgages have been a driving force behind rising defaults and mounting foreclosures.

In Arizona, 128,000 of those mortgages will reset over the the next year and many have started to adjust this month, the state's attorney general, Terry Goddard, told Reuters after the meeting.

The mortgages differ from other ARMs by offering an option to pay only the interest each month or a low minimum payment that leads to a rising balance in the loan's principal. When the balance of the loan reaches a certain level or the mortgage hits a specific date, the borrower must begin making full payments to cover the new amount. The loan's interest rate also may have been fixed at a low level for the first few years with a so-called teaser rate, but then reset to a higher level.

Because the new monthly payments can be five or 10 times what borrowers are accustomed to paying, they "threaten a much greater hit to the consumer than the subprimes," Goddard said, referring to the mortgages often extended to less credit-worthy borrowers that fed the first wave of the financial crisis.

<snip>http://www.reuters.com/article/ousivMolt/idUSTRE58G5U320090917

[grahamhgreen]

1. I read about a year ago these would start hitting in early 2010

[FarCenter]

2. Yes, they really start in 2010 and then run out through 2012

Depending on when they were issued and the terms of the mortgage.

[Mind_your_head]

3. If you see an "interest only" mortgage option.....RUN, don't walk away

from the evil thing.

Seriously!

[Statistical]

5. Option mortages make interest only look like a saint.

Interest only loan say $200K the interest is $1200 per month. You pay that and principle never goes up, never goes down. 1 payment later $200K balance, 1000 payments later $200K balance.

Option loan you pay LESS than interest. Say the interest is $1200 you pay min which is say $500. The principle rises by $700. Now the new loan is $200,700 so the interest rises slightly to say $1212. You pay $500 on payment two, the principle rises by $712. Your new balance is $201,412, interest on that is $1224.....

So as bad as interest only loans are options are 100x worse.

[coalition_unwilling]

17. As Skinner and other DU stalwarts pointed out to me

in response to my query about the metaphor "using your house as an ATM," this type of loan made a perverted kind of sense . . . AS LONG AS HOME PRICES ROSE STEADILY.

In your example, the homeowner who paid less than the monthly interest arrearages expected to sell the home for a higher price than the current loan payoff amount.

I'm not sure this meets the technical definition of a "Ponzi Scheme," but it sure smacks of it to me.

[Statistical]

19. Yup that is the key point... "as long as home prices rise".

Interest only loan makes a lot of sense if housing prices always rise (even slowly).....

Take someone who can afford $x per month....

He can get a 30yr fixed $200K home or $260K interest only loan for the same monthly payment.

If housing prices always rise say 5% annually in 30 years....

At end of 30 years:
The $200K home would be worth $864K and paid off.
The $260K home would be worth $1,123K ($1.1m) and have $200K mortgage for $923K in equity.

So not only does the homeowner have more equity after 30 years on the larger home but they got to buy and live in a nicer home for the same monthly payments.

Of course it doesn't work because eventually the interest only period ends and you can't refinance if housing prices drop.
However when housing prices rose for 13 years in a row it is easy to see how it looked "foolproof" to some.

Why compromise? You can have the larger home, more equity when you retire, and same monthly payment. It is win-win-win and it was until the bubble burst.

[RB TexLa]

11. There is nothing evil about the product or an option loan if used properly

[SammyWinstonJack]

4. K&R

:yoiks:

[Arctic Dave]

6. The article states that these were for less then great creditors.

However I noticed in Anchorage a lot of the higher end homes seem to be the ones with for sale signs on them. I dont know who they think is going to buy a 600,000 + dollar home right now.

[BlooInBloo]

8. Yah - it's been known for some time that the "subprime crisis"...

was really endemic in the entire market. We just saw it explode *first* with subprime.

There are a variety of reasons why the media insists on continuing to speak of just subprime, naturally.

[BlooInBloo]

7. Yep - this has been happening periodically for the last few years...

always a step backwards when it hits. Or two, or three.

[ddeclue]

9. How are these kinds of loans even legal?

They clearly set the borrower up to fail and the bank loaning the money to fail - except that the banks sell out their risk to unsuspecting investors on Wall Street. Why aren't the people who dreamed this up being charged with mail fraud, wire fraud, RICO charges, etc., etc.?

[RB TexLa]

10. Every statement they get has the fully amortized payment, the borrower

chooses to pay the interest only, minimum, fully amortized, or 15 year amortized payment. If they have negative amortization it is because they chose to pay the minimum payment on a house they chose to purchase with a loan product they chose.

[grahamhgreen]

12. Its a con artists dream

[Liberal_in_LA]

13. Why 'buy' something and pay interest only? Renting is a better deal.

[Electric Monk]

14. If you think it'll continue going up in value faster than the extra interest will accrue.

In other words, if you're greedy and gullible and not very good at math.


/Half of all people are only average or below average intelligence. Think about it.

[Liberal_in_LA]

15. Oh... the 'flipper' mentality from pre-2006.

[Statistical]

20. No not just flippers...

At 5% annual price increase over 30 years home prices will apreciate 432%.
A $200K home today would be worth $863 30 years from now.

Even at a more modest 3.5% price increase it is 280% over 30 years.
Rent will go up every year. It goes up because the value of the home goes up.

Having a mortgage is a hedge against inflation. Even not considering the gain in equity your payments are locked in.
People who got an option loan in say 2001 had no problems. As long as housing prices rose you had "options".

When housing fell the options ran out.

[slackmaster]

16. Lack of basic financial knowledge

Home finance should be taught in public schools.

[dionysus]

18. when i was refinancing, i asked the bank person, why the hell would anyone get an ARM. they said

you're only supposed to get an ARM if you know you're selling the house within 2 years. you know you're going to move, and you pay only interest so you can pay off other debts, ect. they are not supposed to be used if it's a house you're going to live in for a while. anyone who suckers people who don't know what they're doing into those has no soul. :(

[Statistical]

21. Well there are other uses....

There are 1/1, 2/1, 3/1, 5/1, even 10/1 ARM.

Say you have a crappy job now and are going to school at nights to be a nuclear engineer. It will take you 5 years to finish school and job prospects look good in 5 years (new power plant being built and lots of engineers are retiring).

You take out a 5/1 or 7/1 ARM because the lower payments today allow you to afford the house.
When the loan resets in 5 or 7 years you can either refinance or you income is larger so you can afford the higher payment.

The problem is anything other than 15year & 30 year fixed are niche products. They have a purpose but you need a specific reason to use them well. Lots of people got duped and lots of people intentionally chose ARM for wrong reasons (I can buy more house for same price).

[Mind_your_head]

22. Yep, LOTS of people got duped.....and the bankers had to KNOW that

some people were only going to move up from working at McDonald's to Applebees :eyes:

There WAS NO I'm going to school to become a nuclear engineer (when there is no demand for nuclear power plants)....and if there were such a demand, it sure isn't here in the US.

edit: spelling (i.e., where to were)