Option
ARMs have benefits and also risks | | |
| These flexible
loans are well-suited to homeowners who have irregular incomes, such as salespeople
on commission or investment bankers who earn a nominal salary and get most of
their income in an annual bonus. But option ARMs have spread beyond those types
of borrowers. Hard numbers are difficult to come by, but option ARMs are much
more popular now than they were 18 months ago.
In a widely cited report this spring, an analyst
for UBS said more than half of borrowers who took out option ARMs in 2004 were
making the minimum payments this year. Testifying to the Senate in July, Greenspan
connected the dots, saying that the loans "are being used to enable people
to purchase homes who would otherwise not have been able to do so." That's
a bad reason to get one of these loans, he added.
When the Fed chairman made those remarks, none of the senators pointed out that,
just 17 months earlier, Greenspan had encouraged homeowners to get ARMs and had
chastised lenders for not offering enough alternatives to fixed-rate mortgages. Risks
vs. benefits
Lenders fume at Greenspan's backtrack
and at the skeptical press that alternative mortgages have been getting lately.
"As much as people want to vilify the mortgage industry, we're not idiots,"
says Walters. "Yes, there are risks -- but there are also benefits. Would
you like to focus on the risks or focus on the benefits?"
The main benefit of the option ARM is its flexibility, allowing the borrower to
make tiny payments when money is tight. Sophisticated borrowers can make minimum
payments and invest the rest. And, as Greenspan noted, some borrowers use the
loans to buy homes that they otherwise couldn't afford.
Option ARMs carry two primary perils. First, they allow people to sink a minimal
amount of money in property that is expected to grow in value, resulting in a
great return on investment. "But," Fed Governor Mark Olson said in a
speech in June, "to the extent that these new mortgage products promote home-buying
decisions that are premised on unrealistic rates of home appreciation, they raise
concerns." Payment shock
The other major risk of an option ARM comes from payment shock. Under certain
conditions, the minimum monthly payment could more than double from one month
to the next. Fitch Ratings established a pessimistic scenario in which the minimum
payment on a $500,000 loan jumps from $2,148 one month to $5,548 the next. Such
an outcome is unlikely, but possible if someone makes only minimum payments for
five years while rates rise. "There are
risks, but they're far less dramatic than the hype of recent months," says
Doug Duncan, chief economist for the Mortgage Bankers Association. "Innovative
mortgage products have allowed a lot of consumers to become homeowners. However,
borrowers need to realize that they're increasing their risk exposure with some
types of products." The Mortgage
Bankers Association just released its own study
of what it calls "innovative mortgage products." The 30-page report
acknowledges that option-ARM borrowers might default more often but says lenders
are giving homeowners what they want. "Borrowers need to be vigilant to be
sure that they are prudently managing the incremental risk that these innovative
new products represent," the report says.
There's that word again: risk. | 
