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The Next Wave of Bad Loans - Option Arms

By
Services for Real Estate Pros with AZ Veteran Notary Services CA BRE 01444168

A friend of mine from San Diego confided in me that they are in serious trouble with their mortgage.  My friend earns good money - and with his wife's income they are way above the medium level for San Diego County - which is high to start with.  I'll call my friend Able - because he has always been more than able to see through different schemes and come out smelling like a rose.  This time, I think he is in trouble.

Able is a 63 year old professional that refinanced his modest home for $618,000, at the peak of the market with an Option Adjustable Rate Mortgage (Option ARM).  This loan program allowed Able to decide monthly which of four optional mortgage plans he would pay, each month.  Since getting the loan, Able always chose the lowest payment - which was actually less than the interest he accrued.

The plan Able and his wife had been to sell their home when he reached 65 and retired - planning on relocating to Palm Springs.  Did I mention that Able thought he knew what he was doing? 

Well, the $2200 monthly mortgage jumped to $2700 with another jump to over $4000 looming in the not too distant future.

The problem is that despite what appears to be a path of recovery for the housing industry there are still more than a half million option ARMs that are scheduled to reset in the next four years! 

Since many of the Sub Prime mortgages have already failed more and more of the Option ARMs are failing and since February, the Option ARMS have exceeded the default rate on the Sub Prime mortgages.

The sad news for Able is that the home is now only worth approximately $400,000, or less, and the balance of his mortgage has risen to over $680,000; since he only made the minimum payments...his principal balance went up every month.

Between 2004 and 2007 over $750 Billion in Option ARMs were made and remain at risk.  The real kicker is that despite the perfect payment history of many borrowers they still cannot refinance their way out of this mess, as their homes are worth so much less today than when they borrowed the money.  About one third of all Option ARMs are currently in default, according to industry analysts.

In comparison to the Sub Prime Mortgages, the borrower of an Option ARM typically had much higher credit scores, better jobs and more to lose than the masses of Sub Prime borrowers who literally walked away from their homes and neighborhoods, in droves.  The Option ARMs tend to have higher balances and when they reset have been known to double the initial monthly payment.

The industry is expecting to see 600,000 or more Option ARMs reset in the next 4 years.  The four payment plans that Able and other borrowers were offered included the interest only, less than the interest (where the difference would be added onto the principal - OK, when you are accumulating equity every month - but really bites in a declining market), fully amortized over both a 15 year and a 30 year fixed-rate-mortgage.

Over 75% of all borrowers never paid more than the minimal payment - less than the current interest rate plan.  This plan was set to reset at either 5 years or when the new principal balance reached a pre-determined level somewhere between 110% and 125% of the original loan.  Then once the ‘cap' is reached, borrowers have to pay down a higher balance at a higher interest rate in a shorter time period.

Like so many other exotic loans, they were great products if used properly.  Unfortunately industry experts expect 81% of the Option ARMs that originated in 2007 to default with many of them ending in foreclosure.

The problem is that the loans were not only offered to those for whom they were designed but to just about everyone with a decent credit score.  People were not taking on these loans because they believed their income would grow over time - they were used by homeowners who believed the equity in their house would increase and that they could refinance out of the teaser rates.

The losses from Option ARMs promises to be staggering.  Another industry expert is projecting at least $112 Billion will be lost by the banks as a result of Option ARMs written between 2005 and 2007.

The good news, if there is any, is that interest rates remain low - so loans are taking longer to reach their cap and will not rest at the higher interest rate until they do reach the cap.

If you don't know whom your congressperson is or how to reach them, check out this link

Blessings to all who read, 

John Occhi, REALTOR®
www.JohnOcchi.Com
Hemet - San Jacinto Valley
951-6564-5550

Servicing THE REO Needs of Asset Managers, Servicers, Banks and Lending Institutions in the Hemet - San Jacinto Valley, Temecula, Murrieta, Winchester, Wildomar, Menifee, Sun Valley, Perris, Moreno Valley, Romoland, Homeland, Nuevo, Banning, Beaumont, Cherry Valley, Yucaipa, Redlands, Mentone, Loma Linda and throughout South West Riverside County and The Pass Areas of The Inland Empire in Southern California.  If you are a buyer, investor, first time home buyer or are just interested in REO real estate, please contact us at the above phone number.

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Until Next Time, Have a Blessed Day,

John Occhi, ePRO, REALTOR®
DRE Lic No: 01444168


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Comments (116)

Peter Just
Corcoran Group - Palm Beach - Palm Beach, FL

jhg It is incredible to even phantom what a mess we are in! What were the a responsible actors thinking?????????????

peterwjust.com

Sep 01, 2009 11:06 AM
Anonymous
Deanne Nelson

I've been reading many of your posts and as always, many opinions.  I truly believe that a blending of all is probably the most accurate.  However, I must say that I find it interesting that the very people (realtors) that sold these homes to people and made good commissions, are now complaining at how "bad" the market is.  Let's face it we all know the financial capability of our clients if we're doing our job.  Part of representing our client is doing due diligence on their behalf, not just to negotiate a good deal regardless of what their capability is.  In other words, I believe that to complain about the consequences that every person from the buyer to the lender (including the realtor AND mortgage broker) is a cop out.  This market is here to stay.  We are NOT going to see a "rebound" as everyone hopes.  Instead of looking for all the bad, accept it for what it is....learn to operate in it and help people as much as possible.

If these people had been smart (c'mon....pay LESS than the accruing interest?...now where's the common sense in that??) they would have lived w/in their means, etc.  Pulling equity, believing that the sky will never fall is just not good business sense, which there is a lack of.... so....sounds more like "keepng up w/ the Joneses" syndrome.

1)I don't agree w/ all the methods out there to get the housing market moving, but I can't control that right now, so I do the best I can to help people move these houses; get new buyers in them and get inventory off the market.  2)Quit bemoaning the fact that we deal w/ short sales and foreclosures all day long.  It is what it is and this is the market.  We can't afford to live in the world of "yesterday" or "when is it gonna get better?".  This is reality ....it's like living in a new world and here we are.

Sorry for the soap box, but we are professionals and our job is to do our best for our clients from all aspects of the transaction.  We do not operate in la la land and we are going to be doing business in short sales; REO's and probably a lot more of the same for the next years.  But, speaking "declining"; "more foreclosures"; just isn't going to help the comfort of the client.  teach them the realities, help them look at their life plan and what is going to be a good fit for them.  Then, do the best we can and move on!  The more we focus on all the wrongs, the longer it will seem to be "bad".

 

Sep 01, 2009 11:21 AM
#98
Renee Thompson
Premier Sotheby's International Realty - Tampa, FL

there is still a lot of distress to come with the Option Arms and regular Arms that are about to adjust. I think we are stabalizing a bit, but the forecast with all of these Arms out there still that it has the potential to be bad again with a lot more foreclosures.

Sep 01, 2009 12:21 PM
Anna Stout
F.C.Tucker Co.-Carmel/Westfield IN Homes for Sale - Westfield, IN

Thanks for this great post.  It's so unfortunate, but it's the new reality.

Sep 01, 2009 12:56 PM
Anonymous
Deborah A. Stone/Realty Source San Diego,CA

I agree with someone who said that the Lenders will just have to roll over these loans into a "fixed rate" mortgage. I mean, how difficult could this be in view of the alternative to foreclose? It is  simply some paperwork and a signature.

For me, this is a "no-brainer".

Sep 01, 2009 01:21 PM
#101
Simon Westfall-Kwong
LuxeLife Group of eXp Realty - Chatham, NJ
The LuxeLife Group of eXp

Really good explanation of this mess.  You should send  it to the press and get some PR out of it.  Thank you.

Sep 01, 2009 04:34 PM
Mark Velasco
West Shores Realty - Whittier, CA
Top Producing Broker Associate

Wow John. This is a ticking time bomb. It is sad to see people lose their homes though.

Sep 01, 2009 05:56 PM
Brett Tousley
Keller Williams Realty - Richland, WA
Tri Cities Real Estate | (509) 420-0013

I may have read your friend's story earlier here: http://www.cnbc.com/id/32580537/site/14081545

Obviously we don't know the whole story, but from what I've read in the two stories it appears "Able"  didn't help the situation by making only the lowest possible payment. 

He'll have to pursue a loan mod, explore deed in lieu options or sell short along with many other homeowners in this market.

The lucky or savvy homeowners in his neighborhood who are not in trouble will share in his misery with reduced property values, and so the snowball rolls down hill. 

 

Sep 01, 2009 07:32 PM
Nancy Filgate
Smart Source Realty - Cedar Park, TX
I love what I do and it shows.

Able misused the Option Arm from Day 1Option Arms are useful for people whose income comes in chunks instead of spaced evenly through the year.  The only time one should use the lowest payment is in months where income was way down and then catch up or get ahead when a big income chunk comes in. Option Arms can be very useful tools if used correctly.

The problem is that just about anything can be misused. So the question is where to draw the line between regulation and protecting us from ourselves and the freedom to choose.Many successful businesses have been started using credit cards which is not what credit cards were meant for. If the person is successful they are a hero and if they fail they were stupid. But what if they never have a chance? I don't know what the answer is.

Sep 01, 2009 11:36 PM
Steven Pahl
Keller Williams Tampa Properties - Tampa, FL
Real Estate Consultant Tampa, FL 813-319-6423

I agree with Brett above, it's the other owners in the neighborhood who aren't in trouble today, but will want or need to sell in the next few years who are going to the most affected.  They will be short sales also and the banks will have to address them just like consumers who are behind in the mortgages today.

Sep 02, 2009 06:46 AM
Dan Chapman
The Legacy Group - Santa Clarita, CA
Dan Chapman Mortgage Pro

I am a lender and had a rental property of mine in one of these option arms based on the MTA-monthly treasurey average. At that time back in 2003-2005 my payment was actually paying all the interest because the index on the MTA was so low so my actual fully amortized rate was around 4.0%. It was a great loan at that time and I always advised my clients to view it as a Short Term loan (2-3 Years) because when rates go up it may not make sense for them but when they were really low it was good for cash flow.

The problem is this loan was sold to way to many people and for all the wrong reasons. If the lenders were just strict on who could qualify and made sure they had a high credit score and low debt to income ratio and at least 20% equitin the property it may have worked but I suspect we won't every see that loan program again and really we should not as the banks have lost billions because of it.

 

Dan

Sep 02, 2009 08:56 AM
John J. Woods
Big Dog Press, LLC - Winder, GA
Going where no man has gone before - wouldn't you?

John, thanks for the information.  I would like to know where you get most of it and the various projections.  I hardly dispute any of it, but it would be helpful for me if you could share your sources, or whichever ones you're comfortable sharing.  Thanks.

Sep 02, 2009 07:15 PM
Kathie Burby
Coldwell Banker Mother Lode Real Estate - Sonora, CA
REALTOR, SFR, Tuolumne County Real Estate Guide

The sub prime fallout was just the tip of the iceberg. Under the water - all those Option-Arms! We have had several businesses (large employers) fail here in the last year. Now all the execs that made "good money" can't afford to keep their homes but no one else can afford to buy them either. I agree the next year looks to be even sadder where foreclosures are concerned.

Sep 03, 2009 12:21 PM
David W. Brown
Thor Design Building & Development, Inc. CL#877779 - San Diego, CA

To the post from Dan above, have you ever heard of the new world order?  The banks may have lost a bit for now, or at least that is what they want us to think, as are so called interest only loan options come due and more money comes out of our pockets into the banks hands.  And that wonderful bailout option:)  I heard of one bank that excepted a bailout and charged some 33 million dollars in fees to except that money.  Basically, we all get screwed and they get our money.  Then when all these lenders we offering all these programs like sub-prime and arm options, and of course ethical brokers put people like Able into these programs.  Who came out on top?  The banks did!!!  And who fell from the empire state building?  Us the consumer, the home-owner, real estate agents, mortgage brokers, and construction company owners:(  Scary stuff.  But, i just think to myself positive thoughts, and good energy is flowing my way.

Sep 03, 2009 09:08 PM
Karen Anne Stone
New Home Hunters of Fort Worth and Tarrant County - Fort Worth, TX
Fort Worth Real Estate

Ahhh yes, David:  The New World Order.  I believe the first New World Order President, or Dictator, is all set !  Chicken Little !  And the first Minister of Defense is going to be Turkey Lurkey !  Uh huh.  Scary Stuff Indeed !  LOL.  Yeah... I can see you're all about thinking positive thoughts.  Uh huh.

Sep 03, 2009 11:38 PM
Randi Brammer
Randi Brammer, Acctg. - Hinckley, MN
Accountant & Tax Preparer

Hi John,
What a great post!  I just wish we could have informed the public a little more about these types of loans before it happened.  Now that all hell is busting loose they want to start asking questions.  I am currently working with a seller (husband died a little over a year ago) that had a fixed rate mortgage for 5 years and now it is coming to the end when it automatically reverts to an ARM.  She is already strapped financially and, to put it quite mildly: in a "Mell of a Hess".  We're working on it, but it looks pretty bleak at this point.

Sep 04, 2009 02:30 PM
Anonymous
DeeDee Riley

John,

What an interesting article!  I have not those loans explained so well. You've made it all come together for me.

Thank you,

DeeDee

Sep 04, 2009 05:25 PM
#113
Anonymous
Lynn Behlendorf

Thanks for addressing the details of the Option ARM and the type of people -- those with good income and great credit -- these loans were given to...I have two of them on homes in the Phoenix area myself and am doing a short sale on each. I would never do an Option ARM agan. I was not in the RE industry at the time, and to honest, the mortgage broker never explained Negative amortization to me, like most people, I just focused on the monthly payment. I think this will hit our industry at least the next two years, if not longer. It's an unfortunated situation for friends like your friend Able, and the who knows how many other thousands of Americans who got stuck with one of these loans. BUt the more unfortunate turn of events is the decline in market values. Like another person said herein, your friend would've been in trouble either way due to declining market values. I guess we're all getting tested as Americans. In the long run, I think we will all be better for it but that does not take away the pain that so many are experiencing because of it.

Sep 10, 2009 06:49 AM
#114
Karen Anne Stone
New Home Hunters of Fort Worth and Tarrant County - Fort Worth, TX
Fort Worth Real Estate

I am sorry, and I do feel badly for you... in comment # 114... but how in the would were you not suspicious when you were told you could get way more house, for a really little payment ?  It's like buying a brand new Mercedes, and being told the payments were $79 a month.  Something has got to be wrong. 

Sep 10, 2009 10:15 AM
Blair Ballin
Hunt Real Estate ERA - Phoenix, AZ

Option ARMS are dangerous. Agreed. Thanks for the info.

Sep 30, 2009 10:24 AM