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Paul Kiesel
Paul Kiesel
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Affluent Were as Susceptible to the Lure of Adjustable Rate Mortgages

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At the peak of the housing boom to purchase homes, many affluent consumers with annual incomes of $100,000 or more were lured into taking out adjustable-rate mortgage (ARM) loans, under the impression that they would be able to lower their monthly mortgage payment (from existing fixed-rate mortgages) or that it would allow them more financial flexibility. In order to secure these lower monthly payments, borrowers (affluent, middle-income, etc.) would be encouraged by the lenders to take advantage of their “Teaser” rate, available through an option ARM loan, wherein the borrower would be paying a fixed monthly payment, under the false pretenses from the lender that the payment was covering the entire amount of interest due every month.

What wasn’t disclosed, in transparent terms to any of these borrowers, however, is that they would only be making a payment on the teaser interest rate of 1 or 1.25 percent (an interest rate that was only available to the borrower for 30 days at best), and not the actual annual percentage rate on the option ARM or jumbo option ARM loan. Therefore, the accruing interest was added to the principal balance, further indicating that these borrowers had been cajoled into a negative amortization loan, which the lender never disclosed in any key and/or clear manner; a red flag that could have kept many borrowers at bay from signing into such a loan. And because home prices continue to fall (down a record 11% from January 2007 in 20 key metropolitan markets) and these option and jumbo option ARM loan payments have reset or will be resetting soon, once the principal balance has exceeded 110 or 115 percent of the original amount borrowed, these borrowers are stuck with a declining asset, an increased monthly mortgage payment and little to no help from their lender.

Most lower-, middle- and upper-income borrowers are not going to be helped much by the falling interest rate, either, as their low initial payments skyrocket and the value of their homes continue to decline. Who is going to want to, or even be able to, continue paying a mortgage that is around $600,000 (original amount of mortgage along with compounded interest), when the home is now valued at $450,000? Now consider that a sizeable portion of ARM loans were jumbo ARMs – mortgages exceeding $417,000 – from 2005 to 2007, and they were taken out on homes that had been appreciating steadily since 2003. And now that those homes are either stagnant in price or dropping in value, how else will these borrowers be able to rid themselves of such ballooned payments and mortgages that have steep prepayment penalties: foreclosing.

In the fourth quarter of 2007, 8.10 percent of jumbo ARMs were two or more payments late, while 2.62 percent were in the foreclosure process. It is now predicted that at least 8 percent of these jumbo ARMS will be foreclosed. Since these jumbo ARMs were taken out with the borrower assuming that he or she could refinance in five years or sell the property after three (as long as the value of their home continued to appreciate), it was hard to resist the idea of lower monthly mortgage payments initially and, on top of that, have extra cash made available via the home’s equity. But now it’s very difficult for these same borrowers to refinance or even sell their homes, while this wave of depreciation crashes over several housing markets. People are afraid to buy as they think the housing market might get even worse before it gets better and this puts borrowers of ARMs and jumbo ARMs in a precarious situation: is it more reasonable to continue making a monthly mortgage payment (when it might substantially exceed the borrowers net income of more than 50 percent) on a home that is declining in value or letting the bank foreclose?

Some borrowers might find it wise to do whatever they can to reach a new agreement with their lender, however, some have found that very difficult to do as the lenders are not willing to work with borrowers whose home’s value continue on a declivitous path.

If the lender is not willing to work with the borrower, the next step is to determine if the borrower lives in a state with nonrecourse laws, because if not, lenders can come after borrowers’ other assets after foreclosure. In states with non-recourse laws lenders cannot pursue borrowers for money owed. Either path is complex and changes often, and the attorneys at Kiesel Boucher Larson, LLP will be able to see what the best option is for that particular borrower.