Option ARMs (Adjustable-rate mortgage) is one of the popular mortgages in the past decade ,it enables the borrower to select from various loan payment options. The interest rate on the note is periodically adjusted based on a variety of indices. Among the most common indices are the London Interbank Offered Rate (LIBOR), the rates on 1-year constant-maturity Treasury (CMT) securities,and the Cost of Funds Index (COFI). These mortgages are typically structured with a low introductory interest rate or teaser rate of 1% which usually resets with in 5 years to a much higher rates. There are as many as four major types of payment options:
1)A fully amortizing 30-year payment.
2)A fully amortizing 15-year payment.
3)An interest-only payment.
4)A minimum payment option that adjusts after the first 12 months.
The option ARM loan program was one of the most popular mortgage choices for borrowers in the United States in the last few years due to its forgiving payment flexibility. This same loan originally was designed for high quality credit borrowers who invest in housing market and wanted to take advantage of payment flexibility, and low payments, but Wall Street abused this financial instrument and starts to use it broadly for anyone who could find. Payment flexibility has also made it one of the most scrutinized loan programs in history because of its sometimes misleading ability to qualify borrowers for a home they truly can’t afford. Typical option arm programs do not have any caps aside from the lifetime cap of 9.95%, though the minimum payment generally increases 7.5% each year until it is no longer an available option.
If you think the worst in behind us and banks are going to be just fine , YOU ARE OUT OF YOUR MIND. I have news for you "option ARMs tsunami" is on the way. It will hit us by mid 2010-2011.
So how big is the next wave of foreclosures? what you should recognize is that prime mortgages on average are significantly larger than sub-prime, and the larger the house and mortgage, means the bigger the loss. With over 50% of mortgages failing coming from prime loans, bigger loan losses lie ahead. The total losses to come is anyone’s guess, but the $11 trillion in outstanding home mortgages could easily produce over $2 trillion in defaulted mortgages!!
It would be fun to see if Bernanke & co. could do any thing, when the Option ARM tsunami hit the U.S. financial industry? He should let those insolvent institutions like City group,Goldman Sachs,AIG,Bank Of America be placed in conservatorship, but he saved his friends in Wall Street. He made this bed, but all of us have to sleep in it. It is coming just wait for the second waves, it would be interesting to see how many of these Zombie banks have the stamina to stand it. The peak of the storm will be in August of 2011. This time banks are weaker compare with the first time, that the first wave of foreclosures hit them. Figure below speaks for its self.