If you're in the banking, loan, or real estate industry, chances are you've been hit by what's now known as the ARM (adjustable rate mortgage) crisis. Nowadays it seems that everyone is feeling the effects of the current peril of the financial market and pointing fingers at who's to blame for the meltdown. And, although "
subprime mortgage" is now a common household phrase, there are still more dread-inducing phrases that Americans will soon find themselves adding to the list.
For those who are unfamiliar with the driving force behind the bursting of the mortgage bubble, an adjustable rate mortgage is the most common type of subprime mortgage that provides consumers with a fixed rate for the first few years, then resets to a "floating" rate for the remainder of the loan. The floating rate is often much higher and subject to change based on other variables. Both 2/28 and 3/27 mortgages are common ARMs where the fixed rate lasts only 2 or 3 years and floats for the remainder of the 30 year loan.
Subprime mortgages are usually granted to those who would not normally qualify for conventional mortgages, due to less than desirable credit ratings. The problem lies in the fact that many homeowners with subprime mortgages have ended up defaulting on their loans. They cannot afford their mortgage payments after their rates adjust, and they go into foreclosure. Many of these subprime mortgages were sold between the years 2004 and 2006, which resulted in skyrocketing foreclosure rates when the introductory rates adjusted. Many homeowners could not afford to pay their mortgages, which lead to the bankruptcy of several of the financial institutions that granted these subprime loans. Many now see that subprime mortgages were a ticking time bomb in the stock market, but experts are saying that we're only half way through the unraveling of that market.
Two other hybrid mortgages are about to become as well known as subprime mortgages:
Alt-A (alternative A-paper) and Option ARM. Alt-A mortgages are considered less risky than subprime mortgages and are credit-score driven. They require less documentation (such as proof of income) than prime loans but have higher interest rates. Option ARM mortgages allow buyers to receive a lower interest rate, often called a "teaser rate," which can be as low as 1 percent. The homeowner pays off only the interest for 3, 5, 7, even 10 years. However, when that rate adjusts, it can be devastatingly high. These loans were heavily marketed to upper-tier home buyers over the last several years. Now, that bubble is about to burst. With the adjustment of those loans' rates fast approaching and default rates already abnormally high, many who feared the worst are about to see those fears come to pass.
The next wave of foreclosures is coming, mainly due to the growing number of defaulting homeowners with Alt-A and Option ARMs. Where subprime mortgages represented about a trillion dollars in loans, Alt-A and Option ARMs represent well over that amount. More than half of these loans are expected to default based on current trends. This isn't good news for the lending industry or for the homeowners who failed to recognize the repercussions of their teaser rate loans.
The ARM crisis is ongoing, and the second half of the mortgage collapse seems inevitable. Some in the industry are saying that it may take up to 5 years to completely rid the system of these "bad" loans. However, if the buyers and sellers of these adjustable rate mortgages have learned anything, it's that the combination of greed and ignorance can have exponentially devastating effects.
By: Danielle Bonk
