Exploding ARMs Roil Bernankes Drive to Calm Markets (Update4)
By Bob Ivry and Jody Shenn
Feb. 7 (Bloomberg) — Joe Ripplinger took out a $184,000
mortgage in 2006 and makes his payments every month.
Now he owes $192,000.
The 66-year-old Minneapolis house painter has a payment-
option adjustable-rate mortgage. It allows him to write a check
for $565 a month even though he owes $1,300. The difference is
added to the mortgage, and when his total debt reaches $212,000,
or after five years have passed, he said his monthly minimum
could jump to about $2,800, which he cant afford.
“Were barely making it right now, Ripplinger said.
The estimated 1 million homeowners with $500 billion of
option ARMs are beyond the help of interest-rate cuts by Federal
Reserve Chairman Ben S. Bernanke. While subprime borrowers face
an average increase of 8 percent or less when their adjustable-
rate mortgages reset, option ARM homeowners may see their monthly
payments double after their adjustments kick in.
“We call them neutron loans because theyre like a neutron
bomb, said Brock Davis, a broker with U.S. Express Mortgage
Corp. in Las Vegas. “Three years later the house is still there
and the people are gone.
Once option ARM borrowers loan balances reach a
predetermined limit, called a negative amortization cap, usually
110 percent to 120 percent of the mortgage amount, their payment
rates immediately increase. They also automatically shoot up
after five years. Otherwise, increases typically are capped at
7.5 percent of a borrowers initial payment per year.
One in Five
“These could be called long-fuse, exploding ARMs, said
Kathleen Keest, former assistant Iowa attorney general and now
senior policy counsel at the Center for Responsible Lending in
Durham, North Carolina. “Ive heard people say they are the most
complicated product ever offered to consumers. They are the real
liar loans.
The loans accounted for 8.9 percent of the almost $3
trillion in U.S. home loans made in 2006, up from 8.3 percent in
2005, according to an estimate by industry newsletter Inside
Mortgage Finance. Originations of option ARMs fell 50 percent
during the first nine months of last year, the newsletter says.
One in five option ARMs packaged into bonds last year
required less than 10 percent down payment and no proof of a
borrowers income, according to a Jan. 22 report by New York-
based analysts at UBS AG, Europes largest bank by assets. Two
percent required no down payment at all from the borrower, the
analysts said.
Better Scrutiny
Delinquency rates on option ARMs tend to be low in the early
years, misleading some investors to think they will remain safe,
said Sean Kirk, a debt trader at Seaport Group LLC, a New York-
based securities firm focused on bonds of distressed or
restructured companies.
Four types of home buyers typically get option ARMs.
Speculators, who plan to sell the property quickly, made up
12 percent of all option ARMs packaged into bonds last year,
according to UBS. That included only borrowers who identified
themselves as investors and not residents, who get lower mortgage
rates. Wealthy people have used the loan for its flexibility,
according to Thornburg Mortgage Inc. in Santa Fe, New Mexico.
The rest either took out the loans as an “affordability
product to buy more expensive homes, according to Standard %26amp;
Poors, or borrowers may have been misled about the terms,
according to federal bank regulators.
Minnesota Legislation
“I never heard of a payment-option ARM before, said
Ripplinger, the Minnesota borrower. “We thought they were
putting us on a 30-year fixed. They didnt put us on a 30-year
fixed. I believe thats why a lot of people are losing their
homes now.
Borrowers who tapped home equity in refinancing represented
more than 44 percent of the option ARMs underlying securities
created in each of the past four years, according to UBS.
Minnesota passed legislation in August requiring mortgage
brokers to act in borrowers best interest, a law that may have
made Ripplingers mortgage illegal, said Brandon Nessen,
executive director of Minnesota ACORN, a housing activist group
in St. Paul.
“You cant make a loan that puts someone in a worse
position than they were in before, Nessen said.
Sophisticated borrowers can take out option ARMs and avoid
problems, said Ira Rheingold, executive director of the National
Association of Consumer Advocates in Washington. Its just that
mortgage sellers marketed them to people who didnt understand
the terms and couldnt afford them, he said.
`Cheat People
“It was used to cheat people, Rheingold said. “It helped
artificially keep housing prices higher than they should have
been.
Delinquencies of more than 90 days on option ARMs increased
to 5.7 percent in the fourth quarter from 0.6 percent in the same
period of 2006 on loans held by Countrywide Financial Corp., the
Calabasas, California-based company said in a regulatory filing
last week.
Lenders hold loans in their portfolios when they dont
bundle them into securities for sale to investors.
Countrywide had $28.3 billion in option ARMs in portfolio at
the end of October, according to Inside Mortgage Finance. The
only banks with more were Charlotte, North Carolina-based
Wachovia Corp., with $117.8 billion, and Seattle-based Washington
Mutual Inc., with $57.9 billion, according to the Bethesda,
Maryland-based newsletter.
Option ARMs, which can adjust monthly, are more attractive
for banks to keep in portfolios than fixed-rate loans because
they adjust at the same time as savings accounts and other
deposits used to fund the loans.
Staying Current
Countrywide wrote down the value of $35 million of the loans
in the fourth quarter, up from $1 million a year earlier,
according to a regulatory filing. The company agreed to be
acquired by Charlotte, North Carolina-based Bank of America Corp.
after losing as much as 89 percent of its market value.
Wachovia-originated option ARMs were higher quality than
other companies option ARMs, Chief Executive Officer G. Kennedy
Thompson said in a Jan. 30 conference call. Thats because the
bank made sure borrowers could stay current on monthly payments
at the reset amount, not just the teaser interest rate, which can
be as low as 1 percent, he said.
That was a standard that regulators, including the Fed,
recommended in 2006 after the total U.S. foreclosure rate climbed
to a five-year high. It has since surged to the loftiest level
since at least World War II, according to data compiled by the
Washington-based Mortgage Bankers Association.
Tougher lending guidelines have made it more difficult to
refinance into new option ARMs.
Regret Making Loans
“The option ARM volume that was done was part of the
excess, IndyMac Bancorp Inc. CEO Michael Perry said in a
telephone interview from his office in Pasadena, California.
IndyMac, the second-largest independent U.S. home lender,
made $43 billion of the loans from 2005 through the third quarter
of 2007.
“Obviously weve been through what weve all been through,
theres many things we regret, Perry said. IndyMac no longer
makes the loans because mortgage-bond buyers arent interested,
he said.
Washington Mutual also is no longer offering option ARMs to
borrowers who put down little or no money or home equity as a
deposit, CEO Kerry Killinger said on a conference call last week.
“Washington Mutual continues to offer option ARMs under
tightened credit standards, Alan Gulick, a spokesman, said
today by phone.
The companys unpaid principal balance of option ARMs
exceeded their original principal amount by $1.73 billion at the
end of 2007, almost double the $888 million of a year earlier,
Washington Mutual reported on Jan. 17.
Regional Banks
Regional banks are feeling the effects of option ARM
delinquencies, said Andrew Laperriere, managing director of New
York-based research firm International Strategy %26amp; Investment
Group.
FirstFed Financial Corp., the Santa Monica, California-based
savings and loan whose net income slumped 75 percent last quarter,
blamed option ARMs hitting their negative-amortization caps for
higher delinquencies. More than 1,800 of its borrowers hit the
limits, and 2,400 more may this year, the company said Jan. 25.
Laperriere estimates that 85 percent of option ARM borrowers
owe more than their original loan balance.
“The problem is, you can refinance an option ARM to a 30-
year conventional loan at a 5.5 percent interest rate, and youre
still looking at your payment going up 150 percent, Laperriere
said. “Thats pretty ugly.
About $460 billion of adjustable-rate mortgages are
scheduled to reset this year, with the next spike in resets
coming in 2011, when $420 billion in mortgages will adjust to new
interest rates for the first time, according to New York-based
analysts at Citigroup Inc.
Thats the year that Joe Ripplingers payment will jump,
provided he doesnt reach his negative amortization cap before
then.
“Its the worst thing we could have done, he said.
To contact the reporters on this story:
Bob Ivry in New York at
