Will the $230 billion in option adjustable rate mortgages (ARMs) create a second wave of foreclosures worse than the subprime mortgage crisis? These dangerous loans are worse than interest-only loans, because borrowers don't even have to pay all the interest each month. Instead, they fall deeper into debt until the loan resets, sometimes tripling the payment.
Although only two percent of all home loans are option ARMS, they are worth $300 billion - and most are likely to default. That's because 60% are in California where home prices have fallen 30-40%, disqualifying borrowers from MakingHomesAffordable home loan modification.
Here's what makes option-arm loans so dangerous.
- Option-arms start with "teaser" rates - about 1-2%. These can reset after the first payment.
- Loans reset at higher rates - even though the fed funds rate has stayed the same.
- Most (80%) option ARM borrowers make only the minimum payment each month. The rest gets added to the balance of the mortgage - just like negative amortization loans.
- Most borrowers think payments are fixed for five years. However, once the unpaid mortgage balance grows to 110% or 125% of the original value, the loan automatically resets - sometimes as much as three times the original payment amount.
- Steep penalties prevent borrowers from refinancing.
- Banks weren't required to report how many option-arm loans they wrote, so no one really knows how many are out there. (Source: "Toxic Mortgages," Center for Responsible Lending,November 5, 2007; "Nightmare Mortgages," Businessweek, Spetember 11, 2006
What It Means to You
Option ARM loans will keep housing prices down by adding to the backlog of shadow inventory. These are homes that are in the foreclosure pipeline and will end up at auction in a year or so. There are widely different estimates of how many homes are in the shadow inventory - anywhere from 1.7 - 7 million. This shadow inventory could keep housing prices flat for anywhere from one to three years.
The shadow inventory is in addition to the real inventory of 3.6 million unsold homes, an 8.6 month supply according to the National Association of Realtors. Another 300,000 homes are added to the shadow inventory each month.
Related Articles
- True Foreclosure Rate Not Being Reported
- Treasury Expands MakingHomeAffordable
- More on the Shadow Inventory
(Credit: Justin Sullivan/Getty Images)
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Comments
Great article Kimberly, thanks!
One of the most dangerous places to be is between somebody e.g. a prospective homeowner, and a perceived pot of money.
Homeowners should be like anyone else and read the fine print; sometimes an ARM might be a good idea, sometimes it might not. The individual concerned should check–especially if there are many long words in the contract which the prospective borrower does not understand!