Some people took exception to a recent post about how alt-A and option ARM mortgages will be the next financial disaster. The argument in the comments of that post is that interest rates are so low that resetting of interest rates won't make the monthly payments higher but rather lower. But a lot of option ARM mortgage holders were not even paying enough per month to cover interest in the first place.
Known as an option ARM — and named “Pick-A-Pay” by World Savings — it is now seen by an array of housing analysts and regulators as the Typhoid Mary of the mortgage industry.
Pick-A-Pay allowed homeowners to make monthly mortgage payments that were so small they did not cover their interest charges. That meant the total principal owed would actually grow over time, not shrink as is normally the case.
Now held by an estimated two million homeowners, the option adjustable rate mortgage will be at the forefront of a further wave of homeowner distress that could greatly delay or even derail an economic recovery, mortgage industry analysts say.
Option ARM is yet another financial weapon of mass destruction.
“This product is the most destructive financial weapon ever deployed against the American middle class,” said William J. Purdy III, a housing lawyer in California who is representing elderly World Savings customers struggling to repay their loans. “People who have this loan are now trapped, and they can’t get another loan.”
People become less willing to make their suddenly higher payments as the price of their house drops and they find themselves financially under water - owing more than their house is worth. In some cases they never would have been able to make the higher monthly payments once the mortgage readjusted to cover interest costs. Some were probably counting on flipping and moving on to another home at that point. But in the game of housing musical chairs when the game stops it is those who are sitting in chairs who lose. These mortgage holders and their banks and the American taxpayers all became losers.
Once upon a time in a distant era regulators didn't think federally insured financial institutions should offer such risky loans.
When Reagan era deregulation arrived, the Sandlers and two other competitors were able to market option ARMs for the first time in 1981. Before that, lawmakers balked at the loan because of its potential peril to borrowers.
World Savings initially attracted borrowers whose incomes fluctuated, like professionals with big year-end bonuses. In the recent housing boom, when World Savings started calling the loan Pick-A-Pay, they began marketing it to a much broader audience, including people with financial troubles, like deeply indebted blue-collar workers.
The risky loans didn't just pull in people who had no business buying houses. These loans so boosted demand for housing that they had the macroeconomic effect of driving up the prices of houses. The rising prices pulled in more fools and so when the bubble inevitably popped it caused the deep long recession and big costs for the net taxpayers.
|Share |||By Randall Parker at 2008 December 26 12:09 PM Economics Housing|