By Eric Forster
I expect to see a wave of foreclosures in the next two years, as Option ARM loans reach their trigger points and are reset by the lenders. Here is what happened to one buyer in Los Angeles:
The buyer purchased a home in 2004 for $1,000,000. As this is Los Angeles, $1 mil doesn’t really buy you much of a house - in this case, a 1,200 square foot house in a typical middle-class neighborhood. The buyer took out a $900,000 Option ARM mortgage, with a starting payment rate (good for the first 12 months) of 1.00%, and a fully-indexed rate of 8.45%, adjusted monthly. A payment rate of 1.00% calls for a monthly payment of $2,895, which is quite a bit lower than the full payment, approximately $6,890 per month. The difference between the minimum payment and the full one, almost $4,000, is added to the balance of the loan.
By the end of the first year, $48,000 had been added to the balance of the loan. A year late, the balance of the loan was $990,000, and the 10% trigger was activated. Under the terms of the loan, whenever the balance of the loan gets to be 110% of the original loan amount, the option of making minimum payment is terminated immediately and the new balance - $990,000 - is amortized over the remaining 28 years using the then-current interest rate (for simplicity’s sake, we’ll assume that the full rate is still 8.45%). The new monthly payment for the next 28 years is reset to $7,577 per month - quite a jump from that original payment, and quite possibly a payment the borrower cannot afford.
The blame for getting into this kind of a loan can be assigned probably to the lender, who didn’t fully explain the ramifications of obtaining a ticking time-bomb, or the realtor who pushed the buyer into a purchase he could not afford. Either way, many attorneys will be kept busy representing Option ARM buyers who’ve lost - or are about to lose - their homes.