According to
Business Week, borrowers who jumped into option adjustable rate mortgage (ARM) loans are in danger of their payments skyrocketing. The ARM is possibly the riskiest and most complicated home loan product yet. The ARM has attractive low minimum payments, which has brought a new group of home-buyers into the market, thus extending the housing boom.
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. Because home prices have leveled off, borrowers cannot count on rising equity to save them. Furthermore, high pre-payment penalty terms prevent such borrowers from refinancing.
According to Business Week, brokers are paid more to sell option ARMs than other mortgage products, and lenders are allowed to claim the full monthly payment as revenue even when borrowers choose to pay much less. Moreover, the option ARM’s interest rates and fees might not have been set by their bank but rather by a hedge fund, which is a lightly regulated private investment fund sometimes characterized by unconventional strategies.
Also, because banks don’t have to report how many option ARMs they underwrite, few choose to do so. Also, banks have protected themselves by selling their option ARMs as repackaged mortgage-backed securities to Wall Street investors, hedge funds and other big investors. Other option ARMs remain on lenders’ books, generating large profits for some lenders, as banks can count as revenue the highest amount of an option ARM payment even when borrowers only make the minimum payment, claiming future revenue now. However, it is difficult to know if unpaid interests and payments will ever get paid.
Option ARMs were initially marketed as flexibility tools to wealthy home buyers who wanted the option of making low payments most months and then paying off a big chunk all at once. However, in the past few years, option ARMs have become affordability tools for the masses in order for the banks to keep the money flowing, without regard to whether such people could deal with or even understood the risks.
Currently, up to 80% of all option ARM borrowers make only the minimum payment each month, according to Fitch Ratings, with the rest of the money getting added to the principal balance, also known as negative amortization. Accordingly, when balances grow to a certain amount, the loans automatically reset at higher payments.
Soon, option ARM borrowers will be confronted with the choice of paying higher payments or losing their homes.