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The sweet deal is ending for thousands of Americans who took out interest-only and payment-option adjustable rate mortgages, or ARMs. After the initial grace period, homeowners are now faced with serious sticker shock -- monthly payments that can double or triple because their minimum payment suddenly goes from 1 percent to 7 percent, for example.
Adjustable Rate Shell Game Can Take Hefty Toll
~ NorthJersey.com | 9/27/2006 | Heather Haddon
Gerard Herard was able to finally purchase a home in 2003 through a $225,070 mortgage from Security Atlantic Mortgage. His payments on the quaint Totowa Avenue house in Paterson were a reasonable $1,300 a month.
But Herard's payments have since increased to $2,200 a month and the mortgage has grown, not shrunk, to roughly $300,000.
Herard is not entirely sure why his situation changed so dramatically and is struggling to deal with the increase. "I'm trying to climb a steep ladder," said Herard, 53.
In recent years, lenders have lured scores of homeowners to untraditional mortgages with changing terms. Many deals allowed minimum payments at artificially low rates for the first year or two of the loan.
But the sweet deal is ending for thousands of Americans who took out interest-only and payment-option adjustable rate mortgages, or ARMs. After that initial grace period, homeowners faced serious sticker shock -- monthly payments that can double or triple because their minimum payment suddenly goes from 1 percent to 7 percent, for example.
Many borrowers took one of these complicated loans without knowing the consequences, and without socking away extra cash for the eventual increase. Some experts fear that the widespread marketing of untraditional ARMs to those who couldn't afford them will fuel foreclosures, and federal entities are calling for more oversight of the exotic products.
"I feel for these people," said Steve Hoogerhyde, a loan officer at Clifton Savings Bank in Passaic. "Now that the piper comes due, they didn't know or didn't understand what would happen. They are really stuck."
Untraditional ARMs come in two main forms. Interest-only mortgages allow owners to pay just the monthly interest on the loan for three to 10 years.
Option ARMs, a more recent fad, present serious dangers, experts say.
Every month, Option ARMs allow owners four payment choices: to pay a 30-year or 15-year traditional loan rate, just the interest, or a minimum payment that's even less.
The minimum payment will be set to a "teaser" rate -- usually from 1 percent to 3 percent of the loan's total. This payment does not cover the interest being applied to the mortgage each month, meaning that the loan total is actually growing, despite the payments.
"I have had calls from people saying that their mortgage started at $300,000, and now it's $315,000," said Tom Cosentino, a mortgage specialist at the Greater Community Bank in Totowa.
The loans come with a cap of how much they can grow in debt, typically 125 percent of the original loan total. After this threshold is hit, the minimum payment typically goes from the low 1 percent or 2 percent to at least 7 percent.
The result is "payment shock," as it is called. If a homeowner was paying the minimum payments on a $400,000 loan, when the loan resents from 1 percent to 7 percent, their payments could go from $1,287 to $2,931, according to scenario cited by a report released last week by the federal Government Accounting Office -- a 128 percent jump.
Untraditional ARMs were originally tailored for wealthy, financially-sophisticated homeowners, according to financial industry publications.
But when housing prices skyrocketed in the early 2000s, lenders began marketing nontraditional ARMs to first-time homebuyers and others who couldn't afford traditional fixed-rate payments. The trend took off, leading companies to relentlessly advertise untraditional ARMs.
Between 2003 and 2005, the interest-only and option ARMs grew from 10 to 30 percent of U.S. mortgage originations, according to the GAO. The report found that New Jersey had one of the nation's highest concentrations of interest-only and payment-option ARMs in 2005 because of the state's high housing costs.
"They were marketed more broadly as affordability products," Orice Williams, one of the authors, said in a telephone interview Thursday.
Wendy Nastasi of Crossroads Finance Discount Mortgage, a Pompton Plains-based company, said that two out of six calls she's received within the last six months have been from untraditional adjustable-rate mortgage-holders.
"Anybody who has one of these now wants out it," Nastasi said.
Untraditional ARMs lenders have said that the mortgages provide flexibility and time for borrowers to save for the growing payments.
But the GAO report found that three-quarters of the untraditional ARMs issued between 2003 and 2005 did not sufficiently check borrowers' incomes to ensure they could afford the higher payments.
As a result, homeowners got in over their heads. Many are confused about what type of mortgage they have.
Herard said that despite working two jobs to try and keep his house, he is fighting off foreclosure. "This situation is bad," said Herard, originally from Haiti and who has thought of moving back. "All this stuff is driving me crazy."
Scrutiny is growing over untraditional ARMs. Critics say that the loans are complicated and ridden with fine print, which may elude first-time homebuyers.
"They lie to people," Nastasi said. "They don't explain the details to them."
Security Atlantic, which issued Herard's loan, has since been investigated by the New Jersey division of the Office of Inspector General. The company's loan default rate was twice the state's average as they approved loans for "potentially ineligible borrowers," according to the 2005 audit.
The GAO is recommending that the Federal Reserve include specific details about untraditional ARMs in the Truth-in-Lending Act. The Fed has promised to establish more guidance around the loans since last year, but they still have not provided a timeline for acting on this, Williams said.
But the beefed up regulations won't save current loan-holders. "You have to cut your losses like it's a bad stock," Cosentino said.
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