'liar Loans' Face Blame For Wiping Out Home Owners

The Age

Saturday February 9, 2008

Bob Ivry and Jody Shenn, New York

JOE Ripplinger took out a $US184,000 mortgage in 2006 and makes payments every month. Now he owes $US192,000 ($A214,000).

The 66-year-old Minneapolis house painter has a payment-option adjustable-rate mortgage (ARM). It allows him to write a cheque for $US565 a month, even though he owes $US1300. The difference is added to the mortgage, and when his total debt reaches $US212,000, or after five years have passed, he said his monthly minimum could jump to about $US2800, which he can't afford.

"We're barely making it right now," Mr Ripplinger said.

The estimated 1 million home owners with $US500 billion of option ARMs are beyond the help of interest rate cuts by Federal Reserve chairman Ben Bernanke. While subprime borrowers face an average increase of 8% when their adjustable-rate mortgages reset, option ARM home owners may see their monthly payments double after their adjustments kick in.

"We call them neutron loans because they're like a neutron bomb," said Brock Davis, a broker with US Express Mortgage 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 amortisation cap, usually 110% to 120% 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% of a borrower's initial payment a year.

"These could be called long-fuse, exploding ARMs," said Kathleen Keest, former assistant Iowa attorney-general and now senior policy counsel at the Centre for Responsible Lending in Durham, North Carolina. "I've 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% of the almost $US3 trillion in US home loans made in 2006, up from 8.3% in 2005, according to an estimate by industry newsletter Inside Mortgage Finance. Originations of option ARMs fell 50% 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% down payment and no proof of income. And 2% required no down payment from the borrower. Delinquency rates on option ARMs tend to be low in the early years, misleading some investors to think they will remain safe.

Sophisticated borrowers could take out option ARMs and avoid problems, said Ira Rheingold, executive director of the National Association of Consumer Advocates in Washington. It was just that mortgage sellers marketed them to people who did not understand the terms and could not afford them.

"It was used to cheat people," Mr 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% in the fourth quarter from 0.6% in the same period of 2006 on loans held by Countrywide Financial Corp., the California-based company said in a regulatory filing last week.

Andrew Laperriere, managing director of New York-based research firm International Strategy & Investment Group estimates that 85% of option ARM borrowers owed 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% interest rate, and you're still looking at your payment going up 150%," Mr Laperriere said. "That's pretty ugly."

About $US460 billion of adjustable-rate mortgages are scheduled to reset this year, with the next spike in resets coming in 2011, when $US420 billion in mortgages will adjust to new interest rates for the first time, according to New York-based analysts at Citigroup.

That's the year that Joe Ripplinger's payment will jump, provided he doesn't reach his negative amortisation cap before then.

"It's the worst thing we could have done," he said.

© 2008 The Age

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