When it comes to the U.S. economy, people are already beginning to wonder if the problems have no end. But it turns out the crisis may be even deeper than most people think.
There is a second mortgage shock heading for the economy. Sub-prime mortgages were bad enough, but there were two other kinds of exotic mortgages that became popular before the housing bubble collapsed, called "Alt-A" and "option ARM." The option ARMs, in particular, lured borrowers in with low initial interest rates, but after two, three or five years those rates "reset" and went up. A mortgage of $800 dollars a month could easily jump to $1,500.
Now the bulk of Alt-A and option ARM loans are starting to reset, causing the mortgage payments to go up and homeowners to default. The mortgage bankers association says one out of 10 Americans is now behind on their mortgage -- the most since they started keeping records in 1979. In the next four years, eight million American families are expected to lose their homes.
It was an offer she couldn’t refuse.
The year was 2004. Mary’s oldest child was heading off to college. She had some unpaid medical bills and credit card debts, and on top of that, college tuition now loomed large. Her teacher’s salary was not stretching as far as it used to.
But no worries—her little house had appreciated at a crazy rate. The $150,000 house now appraised at $300K, and since housing prices never go down, she could look forward to paying off all that debt--and then some--when she sold the house and retired in three years.
But then, Mary heard of some sort of “refi” that people were getting that is “adjustable,” which could lower her monthly payments, so she decided to look into it. After all, what’s the harm in just getting the information, she thought.
So she made the fateful phone call to the mortgage broker…who was more than accommodating to the cash-strapped single mom.
Hmm…a one percent interest rate, cutting the monthly payments in half? Plus, the lender generously offered to pay off her credit cards and wrap that up into her new mortgage, which eliminated several other monthly payments. What’s not to like?
And the best part was, her credit score was so high, she didn’t even have to provide financials—the whole deal was done in less than 2 weeks. She figured she was going to sell the house and turn a tidy profit, long before the interest rate on her option ARM adjusted up.
Of course, the market didn’t cooperate.
Mary was in for a nasty surprise. Not only was she unable to sell her house in 2007, after retiring, but her interest rates skyrocketed at the same time as the value of her home plummeted, leaving her upside down and unable to make the monthly payments.
Like many Americans, Mary faced foreclosure.
Option ARMS Are Probably The Riskiest Home Loan Product Ever Developed
This story, and similar ones, will be headlining far too often in the upcoming months as a second wave of loan defaults hits the lending industry. As opposed to subprime loans, these are alt-A loans and Option ARMs.
According to Wikipedia, an Alt-A mortgage, short for Alternative A-paper, is a type of loan that, for various reasons, is considered riskier than A-paper, or "prime," and less risky than “subprime,” the riskiest category. Alt-A interest rates, which are determined by credit risk, tend to be between those of prime and subprime home loans.
An ARM is an adjustable rate mortgage where the interest rate on the note is periodically adjusted, based on a variety of indices.
An “Option ARM” is typically a 30-year ARM that initially offers the borrower four monthly payment options:
- A specified minimum amount
- An interest only payment
- A 15-year fully amortizing payment, and
- A 30-year amortizing payment
They are also called “pick-a-payment” or “pay-option” ARMs.
Usually, to entice borrowers into these types of loans, ARMs offer very low interest payments upfront—as low as 1%--making the deal look very attractive indeed. However, they are far less attractive a few years down the road, when payments jump to nearly double where they started.
Many of the option ARMs written in 2004 and 2005 are resetting at much higher payment schedules, often to the shock of people who thought the low installments were fixed for at least five years.
And because home prices have leveled off and even fallen, borrowers can’t rely on rising equity to bail them out. Making matters worse, there are steep penalties for refinancing these types of loans.
ARMs came about in 1981 and for years were marketed to homebuyers who needed flexible payments, such as those who are self-employed or who have an unpredictable cash flow. However, the trend has been that people tend to underpay these loans, leading to negative amortization--meaning that the home loses equity over time.
Once this negative amortization reaches a certain level, the payments get kicked up by the lender.
So, if you are struggling to make a minimum payment and losing equity each month, and your lender bumps up your payment, it’s a downward spiral from that point on, and one that often ends, unfortunately, in foreclosure.
This is what is currently happening to a million homeowners right now. One in ten mortgage holders is behind on payments, more than ever before in history.
The second wave of Americans on the verge of defaulting on their home mortgage is approaching with alarming speed. Delinquencies among prime loan holders has doubled in the past year. Banks are making it harder for people to refinance, especially for the people with ARMS. Homes are not selling. More people are losing jobs and are on the financial brink.
Some forecasters are predicting that we’ll begin to see an acceleration of the mortgage crisis in April of 2009, lasting through January of 2010. Hundreds of thousands of borrowers will be seeing their ARMS adjusting upward at that time, and many will fall delinquent. The economic crisis is clearly far from over.
Tools You Need to Soften the Blow
It can be challenging these days to stay grounded while staying informed.
We are all bombarded with news--most of it bad. While it might be tempting to avoid all news and media, living life in a bubble of isolation is not the answer either. Your best bet is to arm yourself with a toolkit for managing stress and being able to respond creatively to the changing times.
Zen Habits has organized a list of all their best money articles as a resource for anyone trying to track finances, get out of debt, save money, or just set up a financial system that works for their own lives. A good starting point for getting out of debt is to read the 12-step guide for getting out of debt.
I have put together a list of sites that offer free online tools and services, created to help consumers save money and manage it wisely. Go to 9 Sites That Help With Everyday Budgeting.
Now, how do you deal with what some call “stinking thinking?” You know, those negative thoughts that keep creeping in, despite repeated efforts to keep them away?
Part of staying grounded is being in control of your thinking so that you can maintain a positive outlook, even in negative circumstances. A corollary to this is minimizing your fear. Once you step into fear, you are thinking about things you are afraid of. Therefore, you are putting your intention on what you don't want, which draws more of that to you.
For example, being afraid of the economy does nothing but manifest more bad economy. This is clearly something you want to avoid!
There are tools that can help you to focus your mind on things you want more of in your life, so that you spend less time thinking about the negatives.
For the past year I have participated in a coaching program developed by Dan Sullivan that has been very useful to me. He has an audio page, available to anyone who wishes to use it, which provides several excellent 5-minute exercises that can help shift your perspective.
Gratitude for what you DO have is one of the best antidotes for feelings of lack. I encourage you to visit Dan’s audio page and try out his first exercise, which will help you connect with feelings of gratitude.
Exercises such as these serve to decrease fear, increase peace and calm, and benefit you in many ways, physical as well as mental. I have written many articles about the interconnectedness of mind and body. Stressing over your financial situation is a perfect example of when you must take care of your mind, in order to take care of your body.