A Bad Option: The Coming Threat of Option ARMs

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Hold on to your Zoloft, yet another wave of bad real estate news is about to wash our already underwater housing market. This time, it's Option Adjustable-Rate Mortgage loans -- or Option ARMs, for short.

What the heck are Option ARMs, you say? Simply put, they are mortgage loans that give homeowners the option to make minimum payments that are so small, they don't even cover the interest, never mind that the principal. The teeny payments eventually reset, but at a much later date.

Option ARMs have been around since the 1980s, but really came into their own in that two year period between 2005 and 2007, when they were peddled by the likes of Countrywide Financial and Washington Mutual to hard-up homebuyers, and some well-to-do ones, too. Who could resist buying a big home for pocket change every month, even knowing that the monthly payments would someday increase? Of course, by that time, the balance would have ballooned as well.

Well, the time of reckoning has come.
The initial period of low rates, called the optional minimum-payment period, typically lasts five or ten years. Now, and is starting to expire -- on an estimated 900,000 home loans, says the Los Angeles Times. That translates into roughly $300 billion of real estate loans.

The director of the Center for Responsible Lending in California (funny, I didn't know there was any "responsible lending" in California!), Paul Leonard, tells the paper, " Unless option ARMs are restructured proactively, large proportions of them could end up in foreclosure, leading to a potential double dip in housing prices in many California markets."

I keep talking about California because, although Option ARMs were marketed from sea to subprime sea, about 44 percent of all Option ARMs 9representing 55 percent of the dollar value) happen to be here in California -- of course! When you add Florida, Arizona and Nevada to the mix, that represents roughly 75 percent of Option ARMs written nationwide.

Now, you want to hear something truly amazing? Well, listen to this:

"The Option Adjustable Rate Mortgage might be the riskiest and most complicated home loan product ever created.. the less a borrower chooses to pay now, the more is tacked onto the balance."

That from a BusinessWeek cover story----in 2006! And, still, suckers (OK, poor suckers, but suckers nonetheless) were sold these bills of good (evil?) as a way to finance their individual American dream. So much for that.

More recently, Time magazine noted that, according to Standard & Poor's, 37.5 percent of option ARMs written in 2007 at the height of the bubble will eventually go bad. Time (always quick to recognize impending doom) asked in its headline: "Is the Option Adjustable-Rate Mortgage the next subprime disaster?"

And, what do you think the magazine's answer to that question is? Well, they'd hardly do a story on it if they thought the answer was no, now would they?


Charles Feldman is a journalist, media consultant and co-author of the book, "No Time To Think-The Menace of Media Speed and the 24-hour News Cycle." He has written about real estate related issues for several years.
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