Banking Law

According to the Los Angeles Times, the subprime mortgage crisis was just the tip of the iceberg when it comes to the global warming meltdown in the wide world of mortgage lending. Next up: option ARMs.

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.

Don't expect Chaz Schumer, Barney Frank, or famous consumer advocate Sheila Bair to call for a bail out of option ARM borrowers. Nope. No government "encouraged" across-the-board loan modifications for these about-to-be-hammered borrowers. You see, these are borrowers who had prime credit scores. If you have a good credit score, pay your bills on time, are responsible with the use of credit, but make one bad decision or are sold a bill of goods by a master mortgage salesperson, well tough nuggies, pal. You rolls the dice, you takes your chances. However, if you have a bad credit score, have a history of not paying your bills on time, have acted irresponsibly with respect to your use of credit, then you're entitled to a break. The only people worthy of a government bailout are those with lousy credit. Get it? That's the American Way.

Ironically, the example profiled by the LA Times is an elderly woman, a retired welfare worker. Astoundingly, she takes responsibility for her bad decisions.

"I have no one but myself to blame," Olsen said, "for signing off on something I didn't understand...I'm going to have to work at least part time."

That's no way to jump on the government hand-out band wagon, Ms. Olsen. You need a pep talk from Sheila Bair. Then you'll be able to adequately restate your position in terms of how unsophisticated you were, how your good credit score was actually an illusion, and, therefore, how you deserve a break today, not from McDonald's, but from the happy meal dispenser called the FDIC, America's foremost promoter of consumer advocacy advice.

Loan Modification & Loan Workout News blog kicks the stuffing out of brokers and lenders, especially Countrywide, for having made so many option ARMs to borrowers for whom the loan was never intended.

[The] facts are that these mortgages have never been sold and are not being used for the purpose of  what they really were intended for. These loans should only be offered to self- employed borrowers and independent contractors who need a flexible loan so they can keep paying their mortgages on time when their business is down. That?s when a borrower can pay the infamous "minimum payment".

The blog's author also is particularly hard on California borrowers, as are some of the commenters. While it's true that the option ARM biz seems to have been "Caifornicated," the problem with option ARMs is not confined to California, nor is it exactly a new issue. For example, in 2006, the Denver Post ran an article about the "ticking time bomb" of option ARMs in Colorado. I assume that Colorado was concerned due to so many Californians moving there to drive up once-reasonable home prices into the stratosphere of California-like price levels (and now, California-like price depreciation levels) and to bring their innovative mortgage products with them. Speaking of "Californication"...

Regardless, the pain of option ARMs has spread beyond La-La Land, and it's only starting to be felt. 2008 may be a bumpy ride, so fasten your seat belts.