CommunityPam's House Blend

Time to pay the mortgage piper

Expect bankruptcies and foreclosures to rise. Option adjustible rate mortgages (ARM) are being given out like candy to people who wanted to refinance at fantasy low rates or get into a home in an overheated market without the huge downpayment necessary.

They are about to be blown away. The “adjustable” part of the deal is coming due.

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. And because home prices have leveled off, borrowers can’t count on rising equity to bail them out. What’s more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk.

…There’s no way to camouflage what Harold, a former computer technician who asked BusinessWeek not to publish his last name, is about to face. He’s disabled and has one source of income: the $1,600 per month he receives in Social Security disability payments. In September, 2005, Harold refinanced out of a fixed-rate mortgage and into an option ARM for his $150,000 home in Chicago. The minimum monthly payment for the first year is $899, which he can afford. The interest-only payment is $1,329, which he can’t. The fully amortized payment is $1,454, which his lender, Washington Mutual, gets to count on its books.

When you continue reading this article, it’s clear that the brokers and banks are running a scam shielding them from risk, and aren’t entirely forthcoming about the pitfalls of these loans. That said, consumers aren’t protecting their finances (or the roof over their heads) by asking hard questions about deals that look too good to be true.

One couple interviewed in the article illustrates the level of inane decision-making going on by too many consumers out there. They gave up a 5.25% fixed-rate, 30-year loan and jumped into an option ARM with a 1% teaser rate. Now, of course, they are screwed because that unbelievable teaser rate has now blossomed to 7.68% and the bottom line on what they owe, due to deferred interest, is skyrocketing to the tune of $600/mo. By the way, the mortgage broker, Indymac Bank, has stopped returning their phone calls.

Stories like these can be found across the socioeconomic spectrum, says Allen J. Fishbein, director of Housing & Credit Policy for the Consumer Federation of America. In a May focus group, the CFA found that option ARM customers at all income levels said the loans were the only way they could afford their homes. While many recognized that their mortgages could increase, “they professed complete surprise that they could increase as much as they could,” says Fishbein. That lack of diligence will cost them over time.

I’m no financial guru, but it seems pretty obvious that a huge economic disaster is around the corner for these people, and the numbers are staggering — as many as 1.3 million borrowers took out as much as $389 billion in option ARMs in 2004 and 2005, according to Business Week, so we’re not talking about a handful of folks.

The option ARM is “like the neutron bomb,” says George McCarthy, a housing economist at New York’s Ford Foundation. “It’s going to kill all the people but leave the houses standing.”

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Pam Spaulding

Pam Spaulding