Mortgage News

Monday, March 03, 2008

Pay-Option Loans - Big Trouble with Small Payments

Today, CNN had an article regarding pay-option arm loans and the risk they are presenting to Countrywide. The article had some very telling statistics that should forewarn many that we are not out of the woods yet regarding this housing downturn.

Here are some quotes and personal observations...

"81 percent of the loans were made out to borrowers who provided little or no documentation on their income"

This is scary especially since majority of the loans where 100% financing. There is only one reason why borrowers elect to use a loan where they don't verify income, starts with an L and it's not Lazy. This simple fact is the beginning of a big problem.


"71 percent of borrowers with pay-option loans were electing to make less than full interest payments."

Keep in mind that many of these loans had mortgage payments and rates at around 2% - 3%. If they are making just the minimum payment, there is alot of negative amortization being added onto those loan balances. When these loans are fully indexed you are talking about rates near 8%, so the balance are climbing at around 5% per year.

As you can see...

"end of December, Countrywide had nearly $29 billion in pay-option loans, with about $26 billion of the total having grown beyond their original loan amount"

Wow, most with higher balances in a depreciating market. It would appear that the borrowers are not even trying to pay down the balances and many are having difficulty making mortgage payments that are exceptionally low...

"5.71 percent of the loans based on unpaid principal balance were at least 90 days late as of Dec. 31,"

The majority that are 90 days late will end up in foreclosure and go back to Countrywide, like this current inventory of REO properties in San Bernardino CA.

Now the scary part. 89% of the loans have higher balances than they started with, adding an average of 3-5% a year.

When the balance gets too high, these loans have a security measure called a "Recast" which usually kicks in at 110% - 125% of the original loan balances. When this happens the loans become fully amortized based on the remaining term and balance at the fully indexed mortgage rate.

When the recast happens the monthly payments jump up dramatically which only add to the number of problem loans. Here is a pay-option ARM loan calculator that estimates the time and adjustments in payments.

So as you can see from the CNN article, the small minimum payments allowed on these loans are now a big problem with lenders like Countrywide and many others.

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