SOURCE: LA Times
“Home values are slowly rising, and interest rates are still at low tide. But some analysts see a hidden reef that could sink the housing market: option-ARM loans.
Option ARMs are adjustable-rate mortgages that give borrowers the option to make minimum payments that don’t even cover the interest owed, much less the principal. That unpaid interest gets tacked onto the principal, increasing the size of the loan.
But there’s a catch: The optional minimum-payment period usually lasts five or 10 years. Because most of the option-ARM loans were funded from 2005 to 2007, the easy-term periods have started to expire.
In a wave cresting through the coming two years, most of the estimated 900,000 borrowers who have option ARMs will lose their ability to make these teaser payments, according to First American CoreLogic, a Santa Ana real estate research firm.
“Unless option ARMs are restructured proactively, large proportions of them could end in foreclosure, leading to a potential double dip in housing prices in many California markets,” said Paul Leonard, director of the Center for Responsible Lending’s California office.
Others may be able to afford the higher payments but could choose to walk away. Median home prices in Southern California have fallen about 46% since 2007, when the last of the option-ARM loans were being written. That means many borrowers will face higher loan payments on homes worth substantially less than they were when they bought them.
Although the mortgages represent less than 2% of all home loans, they carry a total balance of nearly $300 billion — more than half of which is owed by Californians.
For now, rock-bottom interest rates engineered by the Federal Reserve have taken some sting out of the payment increases. But that could change if, as many analysts expect, rates start going up next year.
“Insult is added to injury if the rate environment is higher,” said Mark Fleming, chief economist for First American CoreLogic. “You’re only going to have that benefit until such time as the Federal Reserve decides it’s time to tighten the screw.”
The mortgages, once geared toward affluent borrowers with irregular incomes, were expanded during the housing boom to allow people with lower credit scores, smaller down payments or other handicaps to buy homes.”
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