One of the most popular mortgage loan products sold to homebuyers in the last few years leading up to the bursting of the housing bubble was the option ARM. This loan allows borrowers to choose between a few payments options during the first several years of the loan, giving homeowners the flexibility to pay what they can afford or to vary their payments from month to month. One of the payment options on many of these loans even allows the borrower to pay less than the monthly interest amount due on the loan, increasing the principal amount owed on the property.
A loan like this works just fine when home values are increasing by a double-digit percentage each year but when home values started to decline, these loans became ticking time bombs on the books of many lending institutions. In total, well over $130 billion worth of ticking time bombs. You would think that these are the homeowners who are now in foreclosure, but the fact is that most of these loans are still out there and will reset to higher payment amounts over the next 18 months, creating a new wave of foreclosures. Here are some areas of concern about option ARMs.
– Negative Amortization: Looking back, it’s easy to wonder what lenders were thinking loaning hundreds of thousands of dollars to borrowers who really couldn’t even afford the minimum payment on the loan. Yet it was such a common practice. This feature allows borrowers to increase the loan balance to a defined cap, usually between 110% and 125% of the original loan value. Once this cap is reached or five years passes, the payment automatically jumps to a normal 30 year fixed mortgage, in some cases doubling the monthly mortgage payment. Only 12% of these loans have had the shock of increasing payments so far, and still 46% of borrowers in these lending products are at least one month late in their payments.
– Little Modification: Loan modification efforts have been a big story in recent months as the government encourages lenders to help homeowners avoid foreclosures. For option ARMs, one of the riskiest categories of mortgage loans, only 3.5% have been modified. The modifications have helped–only 24% of borrowers with modified option ARMs are at least three months delinquent compared to 37% of non-modified ARMs, but without further modification, the unmodified ARMs could create a whirlwind of defaults and foreclosures.
– Geographic Concerns: If you had to guess which states had the highest proportion of Option ARMs outstanding, you probably wouldn’t be surprised at the answer. California, Nevada, Arizona, and Florida account for 75% of all outstanding Option ARMs. These states have seen home values fall by an average of 48% since mid 2006 and as these loans get reset, many homeowners will have no option to refinance and will have little choice but to default.
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