Option ARM’s…finally making the news!!!
The image to the left is from this Wall Street Journal article about my favorite ‘bubble’ loan…the option-ARM. This is the loan with 4 payment options and that all enticing introductory 1% (or similar) payment. You can see my post here for more info about the loan.
Like every tool, this loan has it’s place for informed borrowers, or sophisticated borrowers that are trying to manage their cash flow. The problem is that since there is such a disconnect between income and housing prices (especially California), you have people using these loans as a way to ‘afford’ their property. The problem with making that minimum payment is that the difference between that payment, and what the interest only payment would have been, gets tacked on the back of your loan in the form of ‘negative amortization’.
Quick example. Say the minimum payment on a 400k loan is $1200, and the interest only payment is $2200. If you made the minimum payment, then your loan balance would be 401k after one month. Then you would be paying interest on your deferred interest…can you say FUN! So, as you can imagine, like many people do with their credit cards, they make the minimum payment.
I think this statistic from the article is very telling: “the amount of interest that customers are rolling into their mortgage balances — known as “negative amortization” — rose $25 million in the fourth quarter to $63 million for the year, up from $6 million a year earlier”.
YIKES! What does that tell you!?!?? People can’t afford their mortgages. If they could, they would make at least the interest only payment. A 10-fold increase in deferred interest in 1 year!
“Another way to look at it is as a percentage of income. Fully 51% of FirstFed’s pretax income and 41% of its net interest income was from negative amortization in the fourth quarter.” Looks like this negative amortization is a rather large part of their income. The banks are also saying “that their losses on option-ARM mortgages long have been minimal”. I’m sure they are saying that! It is like the analogy I have used several times before. They are driving forward by looking out the back window. There hasn’t been a real catalyst yet that causes things to get ugly. If property prices decline and/or the rates start going adjustible…watch out! But wait….it gets better!
“Moreover, over 80% of FirstFed’s recent loans have been “low documentation” loans, meaning they required less confirmation about whether the customer was a good risk. Through the first nine months of last year, over 13% of its mortgages were NINAs — “no income, no assets.” In other words, customers get mortgages without disclosing their income and assets.”
What I have been saying forever now!!! Not only are people getting option-ARM’s, 80% aren’t even fully documenting their income! Does anybody else see a problem here?!?!? I have been saying it here and on other blogs for many months now. I know some of you will be all worked up about the NINA loans. The thing with NINA’a is that you need a top notch fico score, and the are usually done at lower loan-to-values, than the other loans. Those people are usually putting down 20-40% in cash, so as bad as they sound, I don’t worry about them as much as the 80% of ‘reduced doc’ loans. Depending on the lender, reduced doc is the same as saying ’stated’.
The other thing I will add about these loans, is that they are the highest paying loans available for loan officers and brokers. Every lender is different, but it was pretty standard that if the loan officer ’sold’ the borrower in the 3yr pre-pay, then they would get 3 rebate points on the back of the loan. This means the lender would pay the broker 15,000 on a 500k loan. The “good” brokers would often tell the borrower “I can get you that 1% loan, but the only way I can do it is if you pay 1-point up front, and take a 3yr pre-pay penalty. That is the ‘only’ way I can get you that super low 1% payment!” It is amazing how many people would fall for this line. If you are cringing right now, I feel you. You just paid some loan officer who called you on the phone, $20,000 to do your loan, plus any other fees. You paid 1pt up front, and the lender paid them 3 points on the back. It would make me sick to know I paid some ‘kid’ 20k for my loan. I bet 20k would pay off most people’s car payments right now…or pay off their credit card bills. The thing is, you can get an option ARM with no pre-pay penalty, and the 1% rate…it just doesn’t pay a rebate on the back end. Sell a little pre-pay…make a lot of money. See how easy that is!?!?
I look forward to the comments!
SoCalMtgGuy
February 3rd, 2006 08:10
I had a conversation last night with a LO who works at a credit union. He told me about a borrower who got a loan 1 1/2 years ago for 2%. Now his 2% rate is 7.5%, and if he refinances his loan, he will pay a 2% PPP, his balance has increased and his home hasn’t appreciated like it has in other parts of the country. My friend informed this borrower that most likely refinancing will not help him, in fact, he may not have enough equity to do a refinance anyway. I wonder if Quicken Loans and other option ARM hawkers will run commercials about the recipients of these products 2-3 years later now that the teaser rate has come and gone. I remember interviewing with a broker a few years ago about joining them as a loan officer and they were pushing the option ARM. It was being marketed solely to financial planners, financial advisors, and investors. Now this product is being marketed to anybody. Something tells me that the LO’s aren’t giving them the whole story.
February 3rd, 2006 17:50
Yeah, $20K would take care of most of our car loan. I say “most” because the old car got totalled by a hit-and-run last fall and the best car for us was, in fact, new. (I say best only because we intend to wear it out, AND we have “gap coverage” so we won’t end up upside-down— and it’s a new model style that exactly fits our needs, so no used ones to get.)
My husband asked me to figure out this whole house-buying thing. It’s interesting, because I think it will take me so long to figure out that we’ll actually be able to afford one when I do!