Newsflash: The Next Tsunami Of Aggressively Irresponsible Loans Didn't Magically Disappear
We've been talking about the next wave of the mortgage crisis for quite some time now, and it seems that, as predicted, it's cresting and about to hit. We are, of course, speaking of Option-ARM loans — considered the riskiest of all mortgages due to their ability to grow rather than shrink. Yes, there actually exists a mortgage that allows the borrower to pay less than the interest that is accruing on the loan.
Here is a lovely graph from Credit Suisse that should scare you. As you can see, the subprime resets are now mostly behind us, and the next wave of resets are Option-Arm and Alt-A.
These loans were often issued to borrowers with good credit who were speculating on the housing market or who lacked the proper documentation of income to qualify for a traditional mortgage.
Option-ARM or "pay option" loans are so risky that they are illegal in some states. Option-ARM mortgages allow the borrower to pay little or nothing at first - and any unpaid interest is added to the principal due on the loan. This results in a mortgage that grows over time. Eventually, when the borrower owes 10-15% more than the original loan, the payments increase rapidly. By rapidly, we are talking about 5 to 10 times as much as the borrower was used to paying. These loans tend to be "jumbo" which makes them even more difficult to refinance than regular loans.
Iowa AG Tom Miller is sounding the alarm:
"Pay option ARMs are about to explode," he announced, "That's the next round of potential foreclosures in our country."
Meanwhile in Arizona, where, according to Reuters, 128,000 pay option mortgages are scheduled to reset within the next year, AG Terry Goddard seems sort of depressed:
"It's the other shoe," he said. "I can't say it's waiting to drop. It's dropping now." Right on time.
"Option" mortgages to explode, officials warn [Reuters]
(Photo:rappensuncle)
PREVIOUSLY: Monthly Mortgage Rate Resets, 2007-2016
The Subprime Meltdown Will Be Nothing Compared To The Prime Meltdown
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Comments:
There's always a consequence, regardless of the politicians' attempts to inveigle and distract.
Nothing to worry about, Helicopter Ben and Turbo Tax Timmy can just throw more money at the problem. When in debt make more debt.
My brother has one of these option-ARMs in AZ, ready to explode in about 3 months. He has been trying to get it refinanced through the lender, but they don't return his phone calls, faxes and mail. The comps in his neighborhood are currently less than half what he paid for his place, so I can see why the bank might not be interested. It probably means that his house will be another of the many empty, abandoned and/or foreclosed houses in his neighborhood.
@ChuckECheese: Why did he get such a loan? I just can't understand why someone would make such a shortsighted bet (or maybe that's how it looks with my 20-20 hindsight).
...and some think housing is ready to rebound. LOL!!!
@teh: I'm guessing, but based on conversations, he thought he'd be able to refinance, and/or flip the house. Also, at the time he got the mortgage, he and his gf were making bank at their jobs. After 9 mos of unemployment, she now has a job paying 1/5 what she was making before, and bro's sales commissions have evaporated. I wouldn't have made such a bet even during the boom. Ah, well.
So does this means more cheap houses and lower mortgage rates for those of us who stayed out of the bubble-blowing market over the last few years?
First of all, a 10-15% increase in the principal should not cause a 5x or 10x increase in the payment. Perhaps the introductory rate is expiring at the same time? Second, I've always heard these loans referred to as negative amortization loans. I'd heard the Option ARM thing but thought it was something different. Apparently not.
@teh: It's the opportunity to buy a house you normally shouldn't/wouldn't be able to afford for payments well within your range. I'm not sure if everyone that signed up for these realized how short term the smaller payments would be, but if the terms weren't fully presented to or understood by an unsavvy consumer really itching to buy, I can see why they'd take the bait. I think a lot of people also just thought they'd be able to get some equity in the house and refinance or sell for profit before the terms changed.
Interest only loans are almost just as stupid. Your payments won't adjust, but good luck selling in a down market.
@dilbert69: They are also referred to as "Pick A Payment" loans and marketed with the lowest payment, not the real payment. The reason for the jump is once they grow to the max, they force the payment up to cover what it would be in a traditional fixed rate loan.
It just goes to show how traditional financial companies don't give a rats ass about the people that keep them in business.
@dilbert69: ARM loans are a type of NegAm loan, but NegAm is not limited to only interest rate increases.
@dilbert69: They are both - an Option ARM has a negative amortizing "feature." When I worked on the legal side of the industry, I had a financial expert explain to me the benefits of these loans - they can be of benefit to the wealthy or very high-earning, who have fluctuating income.
Usually you get four options to pay - one is the same as if the loan was a 30 year, fixed at the current adjustable rate, one a 15 year, one pays just the interest, and one pays less than the interest. As the expert said "it was a great loan product for real estate agents." If you make good commissions one month, you make the 30 year payment, if very good commissions, pay the 15 year. If you have low commissions, take the heat off for a few months and pay the less-than-interest payment. The problem with these loans is that no one, at least on the regular consumer level, pays more than the less-than-interest payment.
Were these legal in NC? If so, I might be able to jump on some cheap houses in a couple of years.
@Xerloq wants to...: It probably means more quarters of mortgage holders trying to ignore the problem so they don't have to recognize the diminished value of the "assets" on their books.
Yeah, Mr. Bernanke, recession's over. Oh yeah, and it's still a recession not a depression. Right, you're the expert.
Hindsight being what it is, it's a safe bet that many of these people with option-ARM's were looking to cash in after a couple of years - before the mortgages reset. You know, sell for a nice $100k bet since we all know the value of houses only goes up. Whoops!
@nnj:
It won't until the labor market is healthy again, AND housing is near its inflation-adjusted long-term average (something like 150k for the nationwide median). So, another 10 to 20 percent drop assuming unemployment (bullshit measure or not) is back down by then.
The only basis I have for saying this is that it has happened again and again.
@ChuckECheese:
Of course if they had the more traditional 30 yr mtg or a fully Amortizing loan and she lost her job and his commissions evaporated would they still have the house currently? Maybe the neg-am loan just delayed the inevitable?
@dilbert69:
neg am = pick a pay = option arm
What happens is these things were always a variable rate and once they hit 115% to 110% of the original loan balance they recast. The new payment is Principal and Interest on the fully indexed rate (which was a monthly adjustable in most cases).
@laserjobs: doubtful. they haven't thrown any money in the direction of struggling homeowners up to this point, what makes you think they'll start now?
unless you mean a second helping at the trough for bankers. in that case, yeah, i'm sure that will be their answer.
This has already been priced in. The graph in reference has been around for years, and banks are way ahead of this issue in terms of loan-loss reserves. This will be dealt with in a similar manner to the credit card default crisis from earlier this year, which rose and fell without much incident. The next wave isn't residential real estate, it's commercial real estate, and that's going to take down literally hundreds of local banks.
Anyone that took an Option-ARM loan deserves to loose their house. They are the people that have brought all of this on us. And yes, I know it's still the banks fault too.
When mortgage rates rise real estate values will have to plunge again. People will walk away from their mortgages even if they can afford to pay their fixed-rates
The whole system needs to be overhauled. When the times are good, these people and the banks that lend them money make out like bandits, and when times are bad, the whole economy tanks and we all suffer.
I'm tired of being responsible, not spending more than I can afford, and not jumping on the "get rich quick" schemes that melt down. Isn't this supposed to be a free market? If it's not, then let us know so we can all embrace socialism.
@Buckus: around where my mom lives, these were really popular b/c people essentially rented their $750k homes with the option-arm & simply sold it within 5 years to avoid the reset.
there's really no good reason to take an option-arm that i can think of. maybe if you were expecting your salary to increase greatly within the 5 years, but that doesn't seem like a very responsible way to borrow huge sums of money.
@tailstoo:
The most troubling thing about the financial crisis is our collective retreat into extremist, oversimplified arguments. Economic systems and goverments don't just oscillate wildly between poles, and neither should citizens.
Negative Amortization Adjustable Rate Mortgages are extremely complicated. Here's a moderately detailed description.
Apparently Option ARMs are even more complicated than that. Frankly, I think Neg-Am loans should be illegal. They already are in several States
First of all, a 10-15% increase in the principal should not cause a 5x or 10x increase in the payment. Perhaps the introductory rate is expiring at the same time?
Exactly. So the new payment is based on a real interest of 6.5% (for example) instead of the 1.5% ARM teaser rate they had before. And the payment is also recalculated based on the now inflated principle due at the same time.
Second, I've always heard these loans referred to as negative amortization loans. I'd heard the Option ARM thing but thought it was something different.
That's my understanding as well, but I believe many (perhaps all?) Option ARMs are Neg-Am
Why so negative, Meg?
You see, banks are simply allowing some borrowers to increase the tax write-offs they get from their interest deduction!
Glass half-full!
@TechnoDestructo: Unless Bernanke said that the economy was technically recovering, although in a real sense, we still have far to go. Which he did.
You might want to switch the cable TV station that you rely on for your news if it glossed over these commonly-known facts.
Or keep silent when people wearing long pants discuss such grown-up things, to avoid personal embarrassment.
We had a 1-year option-ARM on our home about 5 and a half years ago that we used as a bridge loan while we were selling our previous home and buying our new one. We ended up only having it for about a month and I was happy to pay it off.
Still, not all ARMS are bad news. Our standard 5-1 ARM just rest last month and the interest rate actually went *down* -- from 5% to 4.25%.
Haven't we been getting warnings about this for the last year, and now it's finally happening?
When I was looking to buy about 2 years ago, I saw commercials for $500K mortgages at $400 a month. I thought it was strange because I can afford $400 a month, but I know I can't afford a $500K house. When I looked at it, not even the allure of buying a $500K house could make me sign up for such a loan, and I'm not usually a rational person with such things.
Part of the reason the payments go up so much, is that you weren't paying the real payment anyway. You may have been paying 50% of the actual payment, now you need to pay 200% of the actual payment, so it ends up being 4 to 5 times what you were paying, not what you should have been paying. (figures completely made up)
@mac-phisto: Who said anything about helping homeowners? No, the homeowners are evil greedy stupid people who signed contracts that they didn't understand and therefore don't deserve help.
No, we must save the poor, poor financial companies like GM and Bear Stearns who were forced by those evil, evil homeowners into signing contracts with ridiculous clauses like "if the homeowner doesn't pay, the bank gets the house" as if the bank would really want a house. No, we must make sure that our tax money goes straight to those who need it most, those poor banks who thought they could take liars at their word and were taken advantage of.
But they get the house too. It's in the contract, after all.
Why are these even legal? Seriously.
I know some responsibility goes to a homeowner for signing up, but why would we allow a bank to do this?
So we get to add this on to the current ongoing wave of people losing their homes because they have no income? Sweet-ass.
@Bob Lu: I know someone in California who managed to turn a fully paid-off house her husband left her into *two* foreclosured properties and sleeping on a friend's couch through the miracle of the option ARM.
@GearheadGeek: The media keeps promising me waves of foreclosures, but there's still air in the bubble in the city I want to move to. Very irritating.
@FDCPAGuy: Yeah, but if everyone that got sub-prime arms, etc, we might not have imploded in the first place or as bad.
I just can't imagine why anyone would get any adjustable rate loan when interest rates where near historic lows.
As a former lender (who refused to sell Option Arm Loans) I can tell you that these are VERY complicated and there is hardly ever a situation where it would be beneficial to the borrower to have an Option Arm...unless buying a house you can't really afford is considered a benefit.
These loans payed out HUGE commissions to Loan Officers and Brokers. So they pushed them on a lot of people especially in rapidly increasing markets like CA and AZ.
They were also so complicated that even the few honest people selling them often did not really know how they worked. They were unable to explain the loan mechanics to their clients- even if they wanted to- and the rarely wanted to.
To make it worse: since the minimum payment (bellow the interest only payment and therefor Negative Amortizing) did not change they often sold these loans as "Fixed Rate." In reality, only the payment was fixed and even that was only fixed for a period of time.
Oh, and for a little extra pain- the almost all have "hard" prepayment penalties. Which meant you were going to pay up to 6 months interest if you refinanced the loan or sold your home and closed the loan within a certain amount of time (from 6 months to 3 years).
In short- probably the worst loan idea ever.
@ChuckECheese: Well, each transaction has an inherit amount of risk. He understood the risk and is now going to feel the short-side of that transaction. Ah, well is right. He's certainly no victim.
That is the Carlsbad power plant in the background of that picture. Yay Carlsbad!