Saturday, September 02, 2006

Risky Business

The new issue of Businessweek features an article regarding Nightmare Mortgages, more commonly referred to as Option ARM's.

While many Americans have started to worry about falling home prices, borrowers who jumped into so-called option ARM loans have another, more urgent problem: payments that are about to skyrocket... The option adjustable rate mortgage (ARM) might be the riskiest and most complicated home loan product ever created. With its temptingly low minimum payments, the option ARM brought a whole new group of buyers into the housing market, extending the boom longer than it could have otherwise lasted, especially in the hottest markets. Suddenly, almost anyone could afford a home -- or so they thought. The option ARM's low payments are only temporary. And the less a borrower chooses to pay now, the more is tacked onto the balance... What's more, steep penalties prevent them from refinancing.

Ouchie Momma.

Stop and think about this for a moment. The vast majority of home buyers do not have the experience to walk in and choose an Option ARM (chances are they never heard of it).

The truth is, they were sold the product.

But why would experienced professional mortgage brokers push Option Arms when rates were scraping along at 45 year lows in 2004? Turns out there's more grease in it.

There was plenty more going on behind the scenes [the borrowers] didn't know about, either: that their broker was paid more to sell option ARMs than other mortgages; that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less; that the loan's interest rates and up-front fees might not have been set by their bank but rather by a hedge fund; and that they'll soon be confronted with the choice of coughing up higher payments or coughing up their home. The option ARM is "like the neutron bomb," says George McCarthy, a housing economist at New York's Ford Foundation. "It's going to kill all the people but leave the houses standing."

Those guys at Businessweek sure are cynical. When there are that many fingers in the pie we call it synergy.

To get the deals done, banks have turned increasingly to unregulated mortgage brokers, who now account for 80% of all mortgage originations, double what it was 10 years ago, according to the National Association of Mortgage Brokers. In 2004 banks began offering fatter sales commissions on option ARMs to encourage brokers to push them, says Gail McKenzie, assistant U.S. attorney in Atlanta, who is investigating mortgage brokers for improper practices. [Rut Roh.]

The problem, of course, is that many brokers care more about commissions than customers. They use aggressive sales tactics, harping on the minimum payment on an option ARM and neglecting to mention the future implications. Some even imply verbally that temporary teaser rates of 1% to 2% are permanent, even though the fine print says otherwise. It's easy to confuse borrowers with option ARM numbers. A recent Federal Reserve study showed that one in four homeowners is mystified by basic adjustable-rate loans. Add multiple payment options into the mix, and the mortgage game can be utterly baffling.

Well, OK... you got a point there.

Unfortunately, this article leaves one hanging, wondering what can these poor people do? How big of a problem is it? Are there any shares available to short?

Prediction: if this turns out to be as widespread as the article implies, two things are going to happen: 1) a lot of these folks are going to "throw the keys at the bank"; and 2) the tobacco lawyers are going to drop what their doing, round up a few million people, and sue somebody (conveniently enough, their job is made easier by that ridiculous paper trail generated every time you close a loan).

(Hat Tip: Seeking Alpha, which has a veritable cornucopia of housing related articles for anyone looking for some weekend reading.)


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