More Option ARMs and Alt-A Loans

Posted by: Peter Coy on October 25, 2005

Yo, yo, yo. Americans’ mortgage choices are getting riskier and riskier. A few minutes ago the Mortgage Bankers Association announced the results of a survey of borrowers from the first half of 2005. (A little old, but I guess it takes awhile to compile the numbers.)

Ordinary ARM loans, which are riskier than fixed-rate loans, apparently aren’t risky enough for many borrowers. The MBA says that their market share fell from 46% in the second half of 2004 to 36% in the first half of 2005. Why? Partly, it seems, because more people chose option ARMs. Those, of course, are specialty ARMs that give you the option to pay even less than the monthly interest you owe. The unpaid interest gets added onto your principal (negative amortization). Option ARMs climbed from 17% to 23% of first-mortgage originations.

Then there are alt-A loans—the ones you get when you don’t submit all the documentation that would be required to qualify for a straight loan. Those are usually chosen by people who have unsteady sources of income—or simply have too little documented income to qualify for a straight loan for the house they want to buy. The MBA says alt-A loans’ share rose from 8% to 11%.

The mortgage bankers’ press release contains a quote from their chief economist, Douglas Duncan: ” … borrowers need to be vigilant to ensure that they prudently measure and manage the additional risk of these new products.”

Ain’t that the truth.

Reader Comments

Option Mortgage

January 6, 2006 11:18 PM

Please be kind enough to yourself and look at the facts:
1) The average person lives in their home for only 6 years according to the National Association of Realtors. During that time a person only pays less than 8% to the principal and a whopping 92+% to interest. Of course the Mortgage Bankers Association does like this loan; they want EVERYONE paying the largest amount of compounded interest money to the bank instead of putting it into a personal retirement account earning compounded interest.
2) When a person applies the monthly savings to a personal retirement account earning compounded interest, over the years, this will yield them hundreds of thousands of dollars when the program is managed by professionals.
3) A penny doubled every day for 30 days is $1,000,000. We all heard that when we were children. Well banks use that 'formula' to get wealthy, SO WE SHOULD TOO!
4) Read the book Missed Fortune 101 and go to my website. You can see all the facts in writing yourself.
Thanks for reading this and click above on the words 'Option Mortgage' to see more.

reader

December 6, 2006 2:22 PM

Please be kind to your readers and avoid the senseless use of slang.

what

May 3, 2007 4:45 PM

@Option Mortgage:
Q: How do you sell a house when you can no longer afford payments and owe more than it is worth?

Q: What happens when subprime mortgages are no longer offered?

A: Whoops.

harith

September 30, 2007 2:26 PM

Pay the difference that you would have paid on a thirty year fixed to a mutual fund, i.e: If your payment would have been 800 dollars on a fixed and 550 on an interest only, put the difference into a 5% mutual fund product or savings account for the initial period of the arm: the 1,2, or 5 years before it adjusts. Refinance and put equity into the investment product before the period ends and repeat this process. Money will be made.

Maetryx

December 22, 2007 1:58 PM

Interest paid on the mortgage is tax deductible, whereas the profit from the mutual fund investment is taxed as a capital gain. So after considering taxes, it's a lot harder to make enough money on your theoretically risk free mutual fund (which by definition have low returns).

Throw in consumer psychology, and you're not likely to see the investment of the saved monthly mortgage payments at all.

Now add falling home prices, a slowing economy, a return to sensible loan criteria, and you have someone that owes a lot more on their house than it is worth and no one to buy it from them (because no one can get crazy loans anymore). Their negative amortization hits the maximum allowed (say 115% of the mortgage value) and it is time to make real payments.

Your model assumes ideal conditions of rapidly rising home values and rigid financial discipline on the part of the borrower. Think about that for a bit and I won't even bother to write down the obvious conclusion.

Evan

January 6, 2009 3:07 AM

These comments are classic today--I wonder what will happen if...? CLASSIC and fatal.

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About

BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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