Tuesday, August 26, 2008

Option ARMS

Yet more good stuff from the economist. Option ARMs - adjustable rate mortgages that allow (give the option) of paying less than the interest rate. The difference is then added to the loan balance. In a down market, you end up owing more than you originally borrowed on a house that is worth less than you paid. Oh yes, and these are mainly in CA.

The name option arm is ironic really because these loans are very much like options, where the buyer of the house is betting on house price volatility and hoping that the value of the house ends up in the money. Consider this fact also - in most cases, if the homeowner has been paying below the market interest rate for the loan for 5 years, he/she will have also been paying far below the rental cost of the property. So even in the case of default, where they loose the house, the occupant has still lived in a house at a lower cost than if they rented.

The trouble isn't going to be centered in CA either, my local bank Wachovia is in on the action...


An option-ARM product called Pick-a-Pay (a name that gave fair warning it could lead to trouble) accounts for 45% of consumer lending at Wachovia, a large bank.