If you’re scared of snakes or option ARMs, stay away from the cover of next week’s BusinessWeek. Its headline: “How Toxic Is Your Mortgage?” A scary green snake has wrapped itself around the bottom two-thirds of a house and threatens to strangle the life out of the family inside.
The story tears into adjustable-rate mortgages – analyzing the threat of resets to the economy, the culture that cash-out refinancing has created and the secretive nature of many lenders and brokers about the actual ins and outs of the loans – a lot of what we’ve talked about before. But what the BusinessWeek story uncovers that I haven’t seen explained so concisely are the motivations for banks, brokers and agents to sign homebuyers up for these loans.
Here’s a taste of those findings:
There was plenty more going on behind the scenes they didn’t know about, either: that [the homebuyers’] 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.
Keeping up with the fear-factor imagery, here’s a scary quote:
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.”
The numbers speak for themselves:
Most of the pain will be born by ordinary people. And it’s already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down – meaning borrowers’ homes are worth less than their debt. If home prices fall 10%, that number would double.
And it looks like those in power have had enough:
…Comptroller of the Currency John C. Dugan, the banking industry’s main regulator, wants banks to clean up their act. A source inside the federal Office of the Comptroller says Dugan intends to raise lending standards, as he did last year on credit cards, where super-low minimum payments made it improbable that cardholders would ever pay down debts. New guidelines are expected this fall.
The article is a great read for understanding these exotic loans in light of what they mean currently (and will mean, especially when they start resetting) for the economy across the country. Check it out, and make sure to click on some of the graphics and ‘online extras’ that outline clear trends for lenders and borrowers.