The Nightmare on Mortgage Street

In the heyday of the housing boom there emerged a loan program that soon became the thorn in the side of every lender that did not have some form of it. In the beginning it was very tough to find fault with the product until the cracks started showing in the foundation of the housing industry.

The program I am referring to is the option ARM loan, and on the surface it seemed like the dream loan, but before you get too excited about it lets put it under the microscope here.

A borrower is given four different payment choices when signing up for this loan. The first is the minimum payment, which doesn’t’ even cover all the interest, and interest only payment, a payment that pays the loan off in thirty years and one that pays it off in fifteen years. Most borrowers, 65% of them, pay only the minimum payment. Borrowers can continue to do that for five years or until their loan balance reaches 110% to 125% of the original loan amount. Anyone see a problem here?

After that borrowers are required to pay a new rate that will have them catching up on the part of the loan that is underwater. In fact on average a borrowers payment increases 65%. Now how many of you out there are fine with an instant 65% increase on your mortgage? I’m going to go out on a limb here and say no one. Defaults on those loans are expected to double.

Now let’s just speculate for a minute on why so many people get into trouble with these loans. And again, this is purely speculation but I think you will agree with me on it. A majority of borrowers who choose these loans are in some kind of stress regarding their house note, and are looking for a way to get relief by reducing their loan payments. Many will have skyrocketing credit card debt that combined with a high mortgage payment has put them in danger of bankruptcy.

For these people the pick-a-pay plan is a Godsend. They simply roll that credit card debt into the new loan and their new low monthly payment doesn’t even break through a grand, providing they choose the minimal payment. Now a struggling family actually has four or five hundred dollars left over every month and they give into the temptation to buy that new Escalade they have been swooning over. In other words they adjust their lifestyle to the tune of five hundred a month instead of making the full payment that they used to pay on the old loan.

Now let’s fast forward five years, five years of counting on that extra five hundred a month, and let’s put a stop to it. Not only are we going to stop that nice monthly wind fall, but we are going to require them to start making up the short fall in the loan, to the tune of a 65% increase. Now you don’t just have a problem here, you have a disaster.

During the housing boom option ARM’s were the only way some people could afford these wildly escalating home prices, and borrowers counted on their homes appreciating enough to be able to refinance out of the loan before reset. The problem with the high priced communities where these loans are, home values have fallen 20-30% and homeowners are finding themselves underwater to the tune of 200,000 or more and unable to sell or afford the new payment.

Now what was once the darling of the mortgage industry has now become the Nightmare on Elm Street. Once the homes are underwater borrowers are gonna have a tough time refinancing them as borrowers are going to close their coffers to those so far in debt. This is a hard lesson in the housing industry that hopefully will not repeat itself and in the meantime hopefully y Obama and his loan modifications can step in and help some of these people out.

In the meantime good luck and happy reading.