Although Downey and World Savings had been in the negative amortization (AKA "neg-am" or deferred interest) mortgage business since the 80s, it wasn't until the turn of the century that the "Option-ARM" (as it is more commonly known) gained prominence and became the product of preference. As the years of the new millennium marched on, so did housing prices. A 30-year, fully amortizing, fixed rate loan became unattainable, as some people couldn't qualify for this financing given that their income couldn't keep up with the appreciation of housing stock. The old adage of "find a need and fill it" was quickly applied in a mighty way to fill this void with the Option-ARM.
Countrywide, Washington Mutual, and Bear Stearns all jumped into the foray as willing suppliers of cash to willing buyers. Owner-occupied homes, condos, duplexes, triplexes and non-owner occupied fourplexes all found their way into various bank's Option-ARM portfolios. Bear Stearns even pushed a 100% neg-am product (can you see why these three entities no longer exist)! I lost many deals to people who swore that they were getting a 30-year fixed at 1.00%. So many people had no clue that every month an additional $200 - $500 was being added to their loan balance until they reached their 110% - 125% LTV cap, after which point they had to pay the interest-only option. It was a prescription for failure and a nightmare in the making. Unfortunately, this nightmare is finally showing up in a neighborhood near you.
A large portion of neg-am loans were booked around 2007. The average neg-am loan due at the 110%-125% caps could endure 3-5 years before the "minimum payment" would hit the cap and could no longer be used as an option for payment. The malaise that has plagued the mortgage landscape thus far has pushed prices down significantly. Given that neg-ams add deferred interest to the principal balance, many homes are even more underwater than their neighbors. So as you can see, the neg-am has created a big ole' mess, and it gets worse. Many people in the industry had concerns that when loan resets occur, (e.g. when the interest rate, often set even lower than the prevailing market rate at the time of loan origination, converts to the potentially much higher rate that is specified in the loan docs) it would trigger a whole new wave of delinquent loans and, eventually, foreclosures. This, my friends is happening now.
Mortgage data from the first quarter shows that the rate of Option ARM foreclosures has increased 23% during the last 180 days and currently stands at 18.8%. This is higher than the foreclosure rate for subprime loans!! The current delinquency rate for option-ARM loans is 23%; this delinquency spreads across property types and loan sizes (e.g. conforming/non-conforming/SFRs/fourplexs).
So the darling product that put a lot of people into homes has the grave potential to put a lot of people out of their homes as well. I am aware of many people who ONLY pay the minimum payment and have never considered paying the interest-only payment. Whether your statement of choice is "they'll have to pay the piper" or "the chickens have come home to roost," both are valid in this instance. World Savings was almost exclusively a neg-am lender. Downey Savings specialized in it as well. Countrywide made billions of dollars off it between 2005-2007. Accordingly, there are billions of dollars in Option-ARMs out for which the time bomb is ticking. What will be the consequences? Examples include more finger pointing, additional congressional oversight, added regulation, a double-dip recession (heaven forbid). Regardless of the result, we will all have a front row seat as this drama unfolds to the next chapter of the Worldwide Mortgage Malaise (WMM).
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