The Problem With Option ARM Mortgages

Feb 2nd, 2009 @ 5:14 PM by Alden Smith

Little is discussed about the option adjustable-rate mortgage. This creative mortgage option hit it s peak during the housing boom. It offered a lot of creative options for people with little options. Prospective buyers were given four ways to pay back these loans, most of them involving low initial outlays that would reset at much higher monthly amounts at a future date. Thirty billion are due to reset this year and $67 billion in 2010, giving rise to more fears of trauma in the housing sector. The average option ARM monthly payment will soar 63 percent - or $1,052.

The real downside to these ARM’s is the fact that when they reset, homeowners will not be able to refi, since their credit rating is not going to be sufficient enough to allow that to happen. Banks have gotten very strict about this score, and consequently home sales are suffering. Because of these conditions, another wave of foreclosures is due to happen, keeping the market in turmoil for years to come. Eric Rothmann, an analyst for Zacks Investment Research, predicts that “the option-ARM resets might plunge 8 million more households into foreclosure. That’s in addition to the 2.3 million facing home loss last year”.

Regulators have seen the option-ARM shipwreck coming. Just to give you an idea of what the soaring housing boom set us up for, realize that option-ARM mortgages accounted for 12% of all housing loans in 2004. Two short years later, they accounted for 1 in 10 of new home loans. It is no wonder that the housing market is in such terrible shape.

These loans required little or no documentation to be issued. You could begin with a low monthly payment that morphed into a negative amortization loan. This effectively put the new buyer into a situation where the principal on the loan would be more than what was borrowed in the first place. When housing prices begin to drop, people were left with a very upside down mortgage that would be resetting to an amount that they could never afford. And that is exactly what happened.

Who were the bad boys in this debacle? We see Washington Mutual, Inc and Countrywide Financial Corp vying for top position here. Countrywide, bought out by Bank of America, set BOA up to stand in line with out-held hand when the bailout money started hemorrhaging out of the Fed’s pocket. BOA is not out of the woods yet, and with the acquisition of Merrill Lynch, could be in big trouble.

We see the new Presidential team making big waves about what it is going to do, yet I have the feeling that this is not going to happen. The biggest error I have seen was shutting out the Repubs when the newest stimulus plan hit the streets. Obama has his hands full with a defiant group of Repubs that I think will fight him tooth and nail on every front, regardless of the outcome. Everyone in Washington promotes their agenda. If you have been around politics as long as I have, you know that Obama is indeed in for a long, hard fight. I doubt that he will see much cooperation from the opposite side of the aisle. And the markets will continue their downward spiral, more homes will be foreclosed on, and the economy will suffer. Such is the way of Washington.

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