Option Adjustable Rate Mortgages Are Housing Crisis’ Next Wave

NPR’s Morning Edition today commented on the fact that the mortgage crisis may just be warming up:

There is growing concern that the home foreclosure crisis may worsen next year as lenders are hit by a new category of loans that haven’t caused much trouble. Bank analysts say they expect delinquency rates on so-called “option ARMs” to continue rising, and those loans could cause as much trouble as subprime loans did.

The radio show said that option ARMs allowed homebuyers to avoid paying down their mortgages, either paying down only the interest or some other specified minimum payment, for up to five years.

Many people who took out these kinds of loans had good credit. They expected to flip their homes before the five-year margin was up, making a profit while avoiding standard mortgage payments.

Unfortunately, that only works in a market where homes appreciate in value. Now that the real estate bubble has burst, homeowners are faced with a nasty 5-year mortgage reset. Because they haven’t been paying down the mortgage every month, the payment amounts will actually be higher than when they bought the house.

One expert noted that option ARMS were first created during the Emergency Home Finance Act in 1970. This act was in part drafted as a response to racial and social unrest in cities. Homes provided edgy people an incentive to mellow out their classist anger. The show states that after widespread defaults and losses, banks gave up on this type of loan.

More recently, they tried again. Unfortunately, it looks like forthcoming results won’t be any different from the first attempt.

  • This is absolutely the case. There are scores of 3 year, 5 year, 7 year and even 10 year arms that are just starting to hit there adjustment cycle. This means that these homeowners will be moving from a low rate, interest only loan, to a little higher rate, amortized loan. And remember, the amortization period will not be 30 years, rather it will be 27,25,23 or 20 to correspond with the initial loan terms. Ouch.