The Next Wave of Foreclosures: Option ARMs

Real Estate Broker/Owner

Whoever said, Jim Cramer, that the housing market has bottomed doesn't know anything about Option ARMs.  Those loans are represented by the light yellow bars in the graph below, the ones that surge in 2010 and 2011. 

Never mind that a record 12% of all mortgages are 30 days late, or that the real unemployment rate is 16.5% and that there is a relationship between job losses and foreclosures, the Option ARM loans represent the next major obstacle to a housing recovery, and the problem with them is that they are not easily diffused with a refinance.  Sorry, President Obama.

By design, Option ARMs were created as an affordability product that would defer interest payments into the loan balance.  The phenomenon is known as negative amortization.

In other words, most owners of these products made a monthly payment that was less than the interest-only paymentRefinancing these Option ARMs into a historically low 30-year fixed rate mortgage will actually increase the payment

The longer the loan was held, the larger the loan balance would be.  Now the problem is that the longer the property is held, the more the home value declines.  Rising loan balances and falling home values don't mix well.

During a rising tide in the housing market these products were risky, during a housing depression with falling home prices, they are radioactive.

Admittedly, while the volume of Option ARMs is smaller than the sub prime tsunami that we saw in 2007 and 2008, keep in mind that we didn't have 467,000 people a month losing their job in 2007 and 2008 either.


Comments (11)

Terry Miller
Miller Homes Group - Tyler, TX
Miller Homes Group and Tyler Apartment Locator

Oh yeah the wave is coming. The administration has no clue of the tidle wave COMING AT US.

Jul 05, 2009 01:35 AM
Rob Arnold
Sand Dollar Realty Group, Inc. - Altamonte Springs, FL
Metro Orlando Full Service - Investor Friendly & F

I've seen some of the numbers on 60 Minutes.  If this isn't a cue to start working the REO business, nothing is.

Jul 05, 2009 01:42 AM
Roy Kelley
Realty Group Referrals - Gaithersburg, MD

We will be selling REO properties for some time. Wonderful opportunities for home buyers and their agents.

Jul 05, 2009 01:49 AM
Fernando Herboso - Broker for Maxus Realty Group
Maxus Realty Group - Broker 301-246-0001 - Gaithersburg, MD
301-246-0001 Serving Maryland, DC and Northern VA

I remain optimistic. . most of those mortgages will be modified or sold as a short sale.

one thing is obvious. .

the real estate and finance  business is not what we experienced before. . we are in uncharted waters and it will change forever more. . 

Jul 05, 2009 02:35 AM
Associate Broker Falmouth MA Cape Cod Heath Coker - Falmouth, MA
Heath Coker Berkshire Hathaway HS Robert Paul Prop

This is useful info. But it only looks at one factor. When the resets happen, AND there is a more stable market, the resets may not have as bad an effect as this graph implies. There are more variables to consider than the doom and gloom of a single predictor.

Jul 05, 2009 02:37 AM
Edward & Celia Maddox
The Celtic Connection Realty - Queen Creek, AZ

As most Short Sales don't close, they will probably be bank owned.  A new wave of bank owned are coming soon and will probably continue for several years.  We have seen nothing yet.

Your Queen Creek AZ Real Estate Specialist

Jul 05, 2009 02:49 AM
Mark MacKenzie
Phoenix, AZ

Heath:  Good points. 

What can't be overlooked is that Option ARMs are a different type of reset than any other ARM, for the reasons I stated above.  Not only will the negative amortization complicate refinances and values because the loan amount has been rising on the loan, but the "new" refinanced payment will be much more than the minimum payment they have been making.  I am not going to pull any punches with Option ARMs, they are going to be a train wreck.


Jul 05, 2009 02:55 AM
John Mulkey - Waleska, GA
Housing Guru

Mark, regardless of how we may dislike the numbers, there's no way to turn them into something positive.  From what I've read, some of these loans are already beginning to default--at today's lower payment rate.  When they are recast, great numbers of the owners will be unable to pay, and foreclosure will be the result. 

Jul 05, 2009 04:16 AM
Brian Griffis
Realty Choice - Springfield, MO

Good point John.  Let's face it, without jobs, how are people going to pay their mortgages?  The government can't pick up the tab forever. 

Aug 15, 2009 09:05 AM
Bev Boeck
My Idaho Place Real Estate, Inc. - Eagle, ID

Thanks Mark--outstanding!  And thanks for allowing the re-blog option...

Sep 01, 2009 03:22 AM
Charles Stallions
Charles Stallions Real Estate Services - Pensacola, FL
800-309-3414 - Pensacola, Pace or Gulf Breeze, Fl.

Right on but we are getting hit from all areas not just arms. I think people are just scared and are walking away. So just don't seem to want the responsibility of home ownership anymore.

Sep 14, 2009 01:50 AM