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Posts Tagged ‘Option ARM’

Why Option ARMs were so common in regular consumer borrowing is beyond me, but Wachovia is the latest lender to see the light.

Beleaguered consumer bank Wachovia Corp. said Monday it will quit offering a mortgage payment option that allows borrowers to pay less each month than the bank charges in interest.

Option ARMs are dangerous because they negatively amortize.

Critics have said paying less than the amount of interest charged can lead to negative amortization. That means the borrower owes more than the value of their home, increasing the chance of foreclosure.

In a rising market, with certain borrowers such as savvy investors, option ARMs aren’t a bad product. But in a falling market, to an owner occupant with no plans to move, they are an awful loan. And the people who have them often have no clue as to how destructive they can be. All they know is that they have a very low (often 3-5%) rate and no idea that the difference gets tacked onto their balance.

“They are taking the riskiest component out, as they should,” said Tony Plath, an associate professor of finance at the University of North Carolina at Charlotte. “There is no one in this market that should be in a loan like that, not right now.”

I concur.

 

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