Thursday, November 13, 2008

From Irvine, CA: ARM recasts are the next financial bomb waiting to go off.

Irvine Housing Blog: "The ARM Problem"

The biggest problem are not the resets themselves, but the recasts. Let me explain a recast. Many ARMs allow you to choose your monthly payment:
  1. A"fully amortizing" payment, which is a normal mortgage payment.
  2. An "interest only" payment, which holds the principal balance the same.
  3. A "minimum" payment, which is a portion of the interest. In this case, the remaining interest is capitalized into the principal balance.
  4. A "catch up" payment, an extra-principal payment which lets you catch up to the amortization schedule (you generally cannot exceed this with other extra-principal payments because of prepayment penalties).
If you make the fully amortizing payment, you are vulnerable to the rate increasing. But if it decreases, you are happy. And, otherwise, you have few surprises. But it's what happens to you if you use one of the other two options without the "catch up" that gets really ugly. If you haven't caught up to the amortization schedule by a certain point, usually 5 years into the mortgage, your payment schedule is recast so you will finish paying the mortgage off in the remaining term. This means all of your payments go way, way up. This can even happen to you if you pay the fully amortizing amount but the rate increased. A recast can also happen if your principal balance increases by more than a certain amount, typically 25%.

The purpose of these so-called "option" ARMs was to give people with highly variable income a chance to manage their payments. If you had bad cash flow, you could pay interest only or even less for a while and catch up later when you got a big windfall. But real-estate agents and bankers got the brain-dead notion that people could buy a house with an option ARM, pay the minimum, and then refinance into a fixed when the house "inevitably" appreciated 20%. For their part, people who really wanted to buy a house went along with it, much to their eventual sorrow.

You'll also see in the blog post I have linked an example of $1.2M Irvine house that fell in value by a third, leaving an overleveraged borrower screaming for help from the government. That's freaking awesome. I mean, I have a lot of sympathy for average borrowers in average situations getting screwed in an average manner. Sure, let's help them out. But my patience is tried when someone who could clearly afford to rent a nice but not awesome place goes out on a limb for a fancy house, partially motivated by speculative greed, gets burned, and expects taxpayers (including me) to bail them out.

That's what frosts me most about the coming option ARM recast bullshit. I could get on board with helping an overextended Joe the Plumber (though not Joe the Plumber himself, because he's an asshole) not lose his modest starter home (which went for about $600,000 in Seattle a few years ago, but anyway). I mean, I could've probably barely afforded a house, but I stayed a renter because I thought it more responsible, and I knew the skyrocketing nonsense was not sustainable. And this is how I am rewarded for my discipline. My house is pretty nice, but I am going to have to dig deeper to keep all you yuppie scumbags in Bellevue and Redmond in your dream homes. That doesn't give me the warm happy happy.

I understand, though, that the alternative is worse, so sure, let's do it. But you numb nuts better not give me any lip next time I agitate for affordable housing in the Seattle area. We helped you; next it'll be your turn.

1 comment:

Melisande said...

Chuck,

60 minutes just did a story on this ARM the past Sunday.

http://www.cbsnews.com/stories/2008/12/12/60minutes/main4666112.shtml