Good-bye sub-prime fiasco, hello Option ARM foreclosures

Every time I get some marketing piece from the loan broker who tried in vain to talk me into an Option ARM loan, I remember how hard she pushed for me to take it as opposed to the 30-year, fixed-rate loan at 5-5/8 that I ultimately chose.

At first glance, it was a tantalizing prospect -- only pay the minimal amount and still be current on the mortgage? It seemed too good to be true, so I started doing my research, and once I saw those forbidding words "negative amortization" coupled with an adjustable rate, I told her no way, no how, not ever. Plus with fixed rates so low, I was only paying a $50 monthly premium for knowing exactly what my payment would be.

Of course it also helped that right after college I worked for a mortgage company, helping to process and create loan documents and knew full well what negative amortization meant. So when my broker wouldn't let it drop, I told her if she mentioned it again I'd take my business somewhere else. Of course now I tell people with good credit and assets to simply go directly to a lender and save themselves some money.

But for those people who didn't understand the pitfalls of Option ARMs, the next wave of trouble will be focused in that arena. From an MSNBC.com story:

...as the housing recession deepens, a coming wave of payment shocks threatens to bring another surge in defaults and foreclosures as these mortgages “recast” to higher monthly payments over the next two years.

“The next wave (of foreclosures) is coming next year and in 2010, and that is primarily due to these pay-option ARMS and the five-year, adjustable-rate hybrid ARMS that are coming up for reset,” said William Longbrake, retired vice chairman of Washington Mutual...

The next wave may be even more difficult to handle than the last one.

“It’s going to get tougher to modify loans as these option ARMs come into their resets," Federal Deposit Insurance Corp. Chairwoman Sheila Bair told msnbc.com this week. "Those are more difficult than the subprime and traditional adjustable rates to modify because there is such a huge payment differential when they reset."

So why did banks promote these loans in the first place? As usual, they were promoting that national value which has eclipsed everything else: greed.

Some time after Sharren McGarry went to work as a mortgage consultant at Wachovia’s Stuart, Fla., branch in July 2007, she and her colleagues were directed to market a mortgage called the “Pick A Pay” loan. Sales commissions on the product were double the rates for conventional mortgages, and she was required to make sure nearly half the loans she sold were "Pick A Pay," she said.

These “pay option” adjustable-rate mortgages gave borrowers a choice of payments each month. They also carried a feature that came as a nasty surprise to some borrowers, called "negative amortization." If the homeowner opted to pay less than the full monthly amount, the difference was tacked onto the principal. When the loan automatically “recasted” in five or 10 years, the owner would be locked into a new, much higher, set monthly payment.

While McGarry balked at selling these pay-option ARMs, other lenders and mortgage brokers were happy to sell the loans and pocket the higher commissions.

Click here for full story.