“Pay-option mortgages” are loans in which homeowners can choose to pay the interest or even just part of the interest on their mortgage each month. If they do this, the unpaid interest is added to the principal resulting in a mortgage that actually grows over time.
These risky (insane!) mortgages are illegal in many states, but that didn’t stop Countrywide from issuing a whole bunch of them anywhere where they could get away with it. BusinessWeek explains in an article from September 11, 2006:
The bill is coming due. Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules — often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can’t count on rising equity to bail them out. What’s more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk.
There was plenty more going on behind the scenes they didn’t know about, either: that their broker was paid more to sell option ARMs than other mortgages; that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less; that the loan’s interest rates and up-front fees might not have been set by their bank but rather by a hedge fund; and that they’ll soon be confronted with the choice of coughing up higher payments or coughing up their home. The option ARM is “like the neutron bomb,” says George McCarthy, a housing economist at New York’s Ford Foundation. “It’s going to kill all the people but leave the houses standing.”
Now it looks like these mortgages may have ballooned out of control.
As of the end of December, Countrywide had nearly $29 billion in pay-option loans, with about $26 billion of the total having grown beyond their original loan amount, the company said in a filing late Friday with the Securities and Exchange Commission.
“Our borrowers’ ability to defer portions of the interest accruing on their loans may expose us to increased credit risk,” the company said. It added that its risk could be greater because the amount of deferred interest on pay-option loans was on the upswing.
The Associated Press says that the number of homeowners missing their interest-only payments is still increasing, and a staggering 81% of borrowers with these risky loans provided little or no documentation of their income.
As of the end of December, 71 percent of borrowers with pay-option loans were electing to make less than full interest payments.
Way to go Countrywide… er we mean “Bank of America.”
Countrywide sees pay-option loan risk [BusinessWeek]
(Photo:Meghann Marco)
More From Consumerist
-
Investors Accuse Bank Of America Of Continuing Countrywide’s Bad Practices
-
Why Paying Celebrities To Lose Weight Is A Risky Endeavor
-
Victims Of Costa Concordia Crash Say Carnival’s Directors Share Blame With Ship Captain
-
Homeowner Says He Lost $250K In Equity To Foreclosure
-
Meet The Final 4 Contenders For Worst Company In America 2013
@nytmare: But…but…but the free market works!
Ok, I gotta chime in now. Hello, nice to meet you, I am on of those “idiots” that got one of these option ARMs. Here’s my story: I live in the LA area, and, as mentioned previously, the rapid run-up in prices in the area scared me. My family lives in the area. My in-laws live in the area. I didn’t want to have to move to the desert to find someplace affordable. At the time, I was making about 40K a year, and my wife’s income was negligible. We were both full-time students and full-time parents in a 1-bedroom apartment. We would both be graduating in a little over a year. We had talked about buying a home, but knew we wouldn’t ever find anything in the area within our price range, and even if we did, we didn’t think we’d ever qualify for a loan. Well, one day, my parents’ neighbor tells them that they are going to be selling their house. Homes in my parents’ neighborhood were going for $500K easy. She agreed to sell it to me for $270K (it was definitely a fixer). According to the WaMu loan rep, the option ARM was the only one we qualified for (even with 30K down), and knowing little about the mortgage industry (no excuse, I should have researched more), we took her word for it. I should have known better, however, when I noticed that she was fudging the numbers on my income and she flat-out told me she was so I could get the loan. But I was caught up in the “we have to have a home, and this was our last chance before all homes cost 750K minimum” hysteria.
I’ll be honest, it was touch and go there for a while, even with payments at the lowest level. Thankfully, we weren’t too proud to ask for help when we needed it and got through it. We’ve never been late with our payments, and now we are getting ready to refi since our income has substantially increased (since we both graduated and got better jobs) and we hope that our credit score has improved significantly with our payment history.
We were lucky. We were able to purchase a home at a semi-reasonable price, so, even with the downturn in the market, we could still sell it. The median price in our neighborhood ($450K) is far above what I owe on it ($250K) so I could underprice the competition and sell quickly if I needed to.
So, yes, it probably wasn’t the best thing in the world to take this loan. I went in with eyes wide open and some reservations, but, personally, giving the home up to foreclosure was never an option. It worked for me, and nobody is bailing me out. My next loan, though, will be a 30yr. fixed. I’ve learned my lesson.
I disagree with everyone who thinks it’s a matter of education. I think we are in this mess because of greed. Greed by the lenders who misrepresented and/or pushed risky loans on people for a quick buck. And greed by people for trying to get something for nothing.
No amount of education can counteract greed.
@fostina1: Hey, I got an idea. Let’s make Donald Trump bail out all the subprime mortgagees. That should solve the problem, and have the added effect of ruining Trump financially. Then we can fire him out of a cannon, into the sun.
@FightOnTrojans:
So did the WaMu loan rep keep her job by fudging more than just your numbers? She got the loan and whatever award for selling the most loans that month/year or the free trip to Cancun. She really didn’t care about the potential issues if you had not been able to make it. And you would not have been able to sue her as she is probably long gone now or would claim you lied to her for the loan…
@LadyKathryn: Well, don’t worry. Thanks to No Child Left behind, both the life-studies and the comprehensive education type classes are nuked. But on the bright side, BOY can our kids answer some multiple-choice questions.
Republicans hate children. There’s no other explanation for it.
@econobiker: I don’t know if she kept her job or what she’s doing now. Like I implied earlier, I don’t believe that anyone else is responsible for my mortgage situation other than my wife and I. She told us what our loan entailed, and I took it knowing what could happen. Like I said, we were lucky in some ways.
Luck had nothing to do with us studying our assess off and graduating and finding jobs and being otherwise responsible with our debts and not refi’ing the hell out of our home so that what we owed would always be far enough below the value of our home that we could sell and pay everyone off and still have something left over. I see what the cash-out refis are doing to people now, and I want no part of that.
Did she make a ton of money off me? Maybe, most likely, yeah. Have I learned? Hell yeah. I’m just glad I’m learning the lesson without the credit score-impacting situations others are experiencing.
I used to be a mortgage loan officer. Once, when I was looking for a new ‘boiler room’…I mean, ‘shop’ to work for…I interviewed with over a dozen mortgage brokers. I cannot tell you how many times I was told that their basic sales plan was to use Option ARMs and sell the $#*! out of them. I blame sleazy brokers, ignorant consumers and greedy lenders for this mess.
I worked in the mortgage industry (on the back end, at a title company) for years. Because of this, I knew a lot more about mortgages and the way loan officers and brokers work than an average person would. I worked closely with Full Spectrum, which a subsidary of Countrywide specifically for borrowers with bad credit. It was unreal what kind of borrowers were getting these loans. People that owed thousands and thousands of dollars worth of debt, people that were in the middle of bankruptcies or foreclosures…. Didn’t matter, Countrywide could get you a mortgage!
They were a joke. I urged friends and family to never use them. We didn’t, and we have a 30 year fixed at 5.25%. We’re young, but we still bought a house we could afford. Our house is the size of a shoebox, but we never have to worry because we know we can afford it no matter what. * (hopefully)
I blame the banks more than the borrowers, I know how high pressure and intense those loan officers and brokers are. It can be very confusing to someone not used to the process.
But then, I would also think that when making an investment as large as buying a home, you want to research as much as possible…. Some people didn’t, and some people did and still got stuck with an ARM.
Doesn’t change the fact that a whole lot of greed was involved.
I am all for blaming people when they make mistakes, but I’ll agree that the going ‘wisdom’ not very long ago was that house prices were going to rise like this indefinitely.
I had many arguments with my parents and my friends trying to tell them that any rate of growth in housing prices greater than the increase in salary rates is not sustainable in the long run, and a growth rate much higher, like we had, wasn’t sustainable even in the short run. If housing prices increased at a greater rate, eventually the median price would reach the point where a monthly payment would be more than the median family can afford to buy a house… at that point housing prices *must* drop unless there is a housing shortage. But at those prices compared to salaries, building is cheap, and new housing would be plentiful.
However, I had a very hard time finding anyone who wouldn’t just repeat blindly that the news said that housing prices were going to keep going up…
You know, interest-only loans are not really all bad, as long as you can afford them. When I bought my place I didn’t have a ton of money to put down, so I got an interest-only 30 year fixed for 80% of the home purchase price, a 15 year amortizing ARM for the other 10% and put 10% down. I just look at the main morgage as fully tax deductible rent. The ARM is now 2/3 paid off and I should be clear next January. I don’t plan to be in the place for more than 5 years and the amount of principal that gets paid on a 30 year amortizing mortgage in the first few years is pretty negligible. I just make sure that I am saving at least as much as I would be paying in interest. I guess my point is that there is a real use for these products, as long as you use them properly and don’t simply use it as a means to over-leverage yourself.
@JeffCarr: “unless there is a housing shortage” – interesting choice of words. In many of the big coastal cities there is definitely an artificial land shortage, which creates an artificial shortage of housing. There is of course a real shortage, in that they ain’t making any more land, but various zoning restrictions, land use regs etc have resulted in a nasty exacerbation effect, and I think that this artificial shortage was a big factor in just how far into the stupid zone housing prices got. When one starts to contemplate a 1.5 hour each way commute, anything closer tends to look good no matter how small and over-priced.
@JeffCarr: Yeah, and 10 years ago the going ‘wisdom’ was that tech stocks would rise forever. It kind of surprises me that as a society we apparently learned nothing from the collapse of that bubble, or at least didn’t apply that knowledge to the next one.
@FightOnTrojans:
I’m glad that things worked out for you but it is this mentality, the “I am entitled to own a home despite the fact I can’t afford it without creative financing and creatively accounting for my income” menatlity, which has caused so many of these problems.
You don’t want to have to move to the desert because houses near your parents are appreciating at 15% per year. Well don’t have kids, don’t hang out in school. I mean one of the tradeoffs of school is the opportunity cost of not working full time. One of the tradeoffs of having kids before you are financially stable is forgoing things you otherwise would have.
As I said, I’m glad things worked out for you. I wouldn’t call it luck. Knowing what you were getting into and how you planned on getting out of it (a better job with your better education) were crucial. However the idea of someone in school with at least one kid and limited income qualifying to repay a nearly 300K mortgage boggles my mind. Maybe it was cheaper than renting but yikes a mortage is supposed to finance a house, not a dream.
The government has to notice things like this that are certain to be a lose-lose situation in the end, and stop them before they start. Maybe there should be more general legislation against ‘malicious’ business practices, allowing the government to identify offending actions as they crop up and take action, rather than needing to see what new evil businesses have cooked up, then writing the laws 6 years later. The problem, though, would be possible abuse of any ambiguous wording.
I agree with SkokieGuy. Otherwise, mark my words, this WILL take our stock market and whole economy down. Just look at how the stock market responds when there’s even a hint that a bond insurer might not go out of business (shoots up). This is the real fear. None of the big money pros knows how the hell this is going to get fixed. That’s why the smart money is all selling U.S. stocks short and buying commodities. And, it better get fixed fast because we live in a speed of thought world. It’s easy to blame the borrower, but the mortgage lenders deserve some of the blame, and therefore should suffer, too. They’re like drug pushers to credit addicts. And, face it, we live in a country full of addiction– whether it’s to the computer, the t.v., shopping (hence, credit), porn, whatever. Our entire advertising industry and, gulp, economy seems co-dependent upon our credit (and otherwise-) addicted culture. Pretty scary. Pass a law converting all payment option arms to 30 year balloon mortgages, with interest rates fixed at the pre-reset rate. Practically speaking, these people, the vast majority, will have no equity left, if they have any left now, the banks are stuck with lower interest payments than they bargained for– but that’s justice since they pushed these unrealistic p.o.a.s in the first place– and the economy is (hopefully) saved from an unmitigated and unending rash of bankrupted mortgage companies, foreclosed homes, ghost towns and “for sale” signs, and a complete stock market meltdown. Let’s beat the money pros at their own game by showing them we’re smarter than they think we are, keep our U.S. common stocks, and FIX THIS NOW.
Tighter lending standards would be a solution I could get behind. I’m not even talking about restricting ARMs or other exotic mortgages – just make sure that everyone understands what they’re getting into. That would include the buyer not lying about their income, the banks fully explaining how the loan works, and then VERIFYING that knowledge.
A bunch of entities (banks, lenders, borrowers, brokers, real estate agents) got greedy and took a huge gamble. Their gamble failed, and now they’re screwed. I don’t see the reason to bail them out – if the gamble had succeeded, would I have seen any of the profits? No? Then why should I share the losses?
And I don’t buy the argument of “it’ll hurt the economy more to not bail them out”. A functioning economy needs risk to be commensurate with reward. When you distort that relationship, you’re going to cause even more bad behavior in the future. Pay a dollar today, or a hundred tomorrow. Your choice.
@Trai_Dep: Politicians hate children. (No money, no vote).
There, fixed that for you.
@Orv: Look out for the next bubble sequel: Corn and wheat. Except this time, people won’t just go broke, they’ll go hungry. Sorta reminds me of Revelation 6:6. Until biofuels, I always wondered how you could have a famine where only grains were affected, but not the other stuff.