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Nightmare Mortgages
September 11, 2006 (Business Week)
They promise the American Dream: A home of your own -- with ultra-low rates and payments anyone can afford. Now, the trap has sprung
For cash-strapped homeowners, it was a pitch they couldn't refuse: Refinance your mortgage at a bargain rate and cut your payments in half. New home buyers, stretching to afford something in a super-heated market, didn't even need to produce documentation, much less a downpayment.
Those who took the bait are in for a nasty surprise. 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.
There was plenty more going on behind the scenes they 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."
Because banks don't have to report how many option ARMs they underwrite, few choose to do so. But the best available estimates show that option ARMs have soared in popularity. They accounted for as little as 0.5% of all mortgages written in 2003, but that shot up to at least 12.3% through the first five months of this year, according to FirstAmerican LoanPerformance, an industry tracker. And while they made up at least 40% of mortgages in Salinas, Calif., and 26% in Naples, Fla., they're not just found in overheated coastal markets: Through Mar. 31 of this year, at least 51% of mortgages in West Virginia and 26% in Wyoming were option ARMs. Stock and bond analysts estimate that as many as 1.3 million borrowers took out as much as $389 billion in option ARMs in 2004 and 2005. And it's not letting up. Despite the housing slump, option ARMs totaling $77.2 billion were written in the second quarter of this year, according to investment bank Keefe, Bruyette & Woods Inc.
AntiSpin: Out go the homeowners and in come the vultures. Yesterday I received the attached letter offering to let me in as an investor in Stronghold Funding's investment products. "As mortgage default notices soar 67% last quarter in the state of California, over 20,000 homeowners were warned by lenders of sub- to non-performing status. As the market continues to soften, we are receiving more quality product then we are able to currently fund. Seldom do we open this opportunity to outside investors, but due to the abundance of exceptional discounted product, we are interviewing potential investors who would like to particpate in capturing above average returns using an established system and business model."
Imagine my delight to be offered an exclusive opportunity to be interviewed to see if I qualify as in investor to make a bundle off option ARM neutron bomb fallout. Get in on the ground floor, so to speak. One family's home loss is another man's "abundance of exceptional discounted product."
The purist libertarians out there in iTulip land -- by our polls, something like 20% of you -- might say, "That's capitalism for ya." I'm partially sympathetic, that the buyers of these loans are adults and should know the risks. Except that loan sharking*, like selling option ARMs without requiring the borrower to produce documentation or a downpayment, is also capitalism. The difference is that the former is illegal and the latter should be, and for the same reason: offering loans at usury rates of interest to desperate borrowers under threat of loss of property is bad for society.
At minimum, these loans need to carry a HUGE warning label, like packs of cigarettes do, that says something along the lines of: "This Option ARM is dangerous to your financial health. You could lose your home." This bold face notice should be followed by a checklist of various things that can go wrong that could result in foreclosure, include industry default rate statistics for that type of mortgage relative to a fixed rate mortgage, and so on. The broker must read this to the prospect, and check off each item, and both the prospect and broker must sign the checklist to certify that it has been read and the borrower understands it, all of this before the broker even gets to start to sell the loan.
Before this simple method of consumer protection is put in place, no doubt a few million home owners will have to turn turtle, financially speaking, just as cigarettes had to literally kill a few million smokers before the law caught up to Big Tobacco because... that's how we do it here in the USA!
Until then, keep your eyes open for the Option ARM/Ambien Prescription Package: The Option ARM for the home you "should" be able to buy, and the Ambien so you can sleep at night after you do.
p.s. David Sanders, if you're reading this, the answer is: "No, thanks."
* "Lending by those who provide credit to those who cannot obtain it from more respectable sources, usually because interest rates commensurate with the perceived risk are illegal."
September 11, 2006 (Business Week)
They promise the American Dream: A home of your own -- with ultra-low rates and payments anyone can afford. Now, the trap has sprung
For cash-strapped homeowners, it was a pitch they couldn't refuse: Refinance your mortgage at a bargain rate and cut your payments in half. New home buyers, stretching to afford something in a super-heated market, didn't even need to produce documentation, much less a downpayment.
Those who took the bait are in for a nasty surprise. 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.
There was plenty more going on behind the scenes they 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."
Because banks don't have to report how many option ARMs they underwrite, few choose to do so. But the best available estimates show that option ARMs have soared in popularity. They accounted for as little as 0.5% of all mortgages written in 2003, but that shot up to at least 12.3% through the first five months of this year, according to FirstAmerican LoanPerformance, an industry tracker. And while they made up at least 40% of mortgages in Salinas, Calif., and 26% in Naples, Fla., they're not just found in overheated coastal markets: Through Mar. 31 of this year, at least 51% of mortgages in West Virginia and 26% in Wyoming were option ARMs. Stock and bond analysts estimate that as many as 1.3 million borrowers took out as much as $389 billion in option ARMs in 2004 and 2005. And it's not letting up. Despite the housing slump, option ARMs totaling $77.2 billion were written in the second quarter of this year, according to investment bank Keefe, Bruyette & Woods Inc.
AntiSpin: Out go the homeowners and in come the vultures. Yesterday I received the attached letter offering to let me in as an investor in Stronghold Funding's investment products. "As mortgage default notices soar 67% last quarter in the state of California, over 20,000 homeowners were warned by lenders of sub- to non-performing status. As the market continues to soften, we are receiving more quality product then we are able to currently fund. Seldom do we open this opportunity to outside investors, but due to the abundance of exceptional discounted product, we are interviewing potential investors who would like to particpate in capturing above average returns using an established system and business model."
Imagine my delight to be offered an exclusive opportunity to be interviewed to see if I qualify as in investor to make a bundle off option ARM neutron bomb fallout. Get in on the ground floor, so to speak. One family's home loss is another man's "abundance of exceptional discounted product."
The purist libertarians out there in iTulip land -- by our polls, something like 20% of you -- might say, "That's capitalism for ya." I'm partially sympathetic, that the buyers of these loans are adults and should know the risks. Except that loan sharking*, like selling option ARMs without requiring the borrower to produce documentation or a downpayment, is also capitalism. The difference is that the former is illegal and the latter should be, and for the same reason: offering loans at usury rates of interest to desperate borrowers under threat of loss of property is bad for society.
At minimum, these loans need to carry a HUGE warning label, like packs of cigarettes do, that says something along the lines of: "This Option ARM is dangerous to your financial health. You could lose your home." This bold face notice should be followed by a checklist of various things that can go wrong that could result in foreclosure, include industry default rate statistics for that type of mortgage relative to a fixed rate mortgage, and so on. The broker must read this to the prospect, and check off each item, and both the prospect and broker must sign the checklist to certify that it has been read and the borrower understands it, all of this before the broker even gets to start to sell the loan.
Before this simple method of consumer protection is put in place, no doubt a few million home owners will have to turn turtle, financially speaking, just as cigarettes had to literally kill a few million smokers before the law caught up to Big Tobacco because... that's how we do it here in the USA!
Until then, keep your eyes open for the Option ARM/Ambien Prescription Package: The Option ARM for the home you "should" be able to buy, and the Ambien so you can sleep at night after you do.
p.s. David Sanders, if you're reading this, the answer is: "No, thanks."
* "Lending by those who provide credit to those who cannot obtain it from more respectable sources, usually because interest rates commensurate with the perceived risk are illegal."
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