Thought the mortgage meltdown was just a sub-prime affair? Think again. There's another time bomb waiting to explode, experts say: risky loans made to people with good credit.
So-called pay-option adjustable-rate mortgages, or option ARMs, were the easiest and most profitable home loans for lenders and brokers to make for much of this decade. Last year, they accounted for about 9% of the volume of all mortgages made in the U.S. and were especially popular in California, Florida and Nevada -- states where home prices rose the most during the housing boom and are now falling most sharply.
An option ARM loan gives a borrower the option of paying less than the interest due, causing the loan balance to rise. If it rises too much -- say, by 10% or 15% -- the opportunity to make a low payment vanishes and the required payment skyrockets.
That scenario is becoming increasingly common. In fact, more than 75% of option ARM borrowers have been making only the minimum payments, analysts at Standard & Poor's Corp. said last week. As a result, the delinquency rate on option ARMs already is jumping and is likely to keep rising sharply, S&P said. Because option ARMS went only to "prime" borrowers, they aren't eligible for a much-publicized interest rate freeze that is part of a White House-backed plan to stem sub-prime foreclosures.
One upshot could be foreclosures growing more common in affluent neighborhoods.
"Whether it's a wealthy community or a sub-prime community, it all comes down to how much equity the borrower has and how much home prices fall," said Joshua Rosner, a managing director at investment research firm Graham Fisher & Co.
Option ARMs were originally offered in the 1980s by California savings and loans as a way to give some financial flexibility to self-employed people and others with variable incomes. But as homes became more expensive this decade, they became increasingly desirable simply because of the ability to make extraordinarily low payments for a good period of time.
"The only reason for taking [an option ARM] was to use the minimum payment to get more house or a bigger refi than you otherwise could afford," said Guy Cecala, editor of Inside Mortgage Finance.
Attractive payment option
