Option ARMs, next chapter in U.S. housing crisis

By Nick Carey

CHICAGO (Reuters) - The U.S. housing crisis has focused attention on adjustable rate mortgages (ARMs) and the danger posed by their spiking interest rates.

But mortgage bankers, industry experts and nonprofit officials say that the impact of one particularly nasty kind of ARM -- called the Option ARM -- involving hundreds of billions of dollars of loans has yet to be felt. And, they say, it will hit prime borrowers and subprime borrowers alike.

People like Bruce Rose, 53, who never should have got a loan.

Rose, 53, bought his home in Boston in 1986. After stress and depression forced him to retire as a state employee in April 2006 he "maxed out" his credit cards on his annual income of around $16,000.

On medication, he refinanced his debts through the largest U.S. mortgage lender, Countrywide Financial Corp CFC.N. The new loan totaled $439,000. Rose said he did not know his mortgage broker and Countrywide used a stated income loan -- also called a "liar loan" because no proof of income is required -- and that they claimed his monthly income was $12,166.

"If I had known what I was signing I would never have agreed to the loan," he said. "Now I may lose my home."

With an Option ARM, borrowers can make a minimum monthly payment like a credit card, but if they do the principal increases. Rose's minimum payment rose from $1,200 a month to $2,800 and his loan now totals more than $500,000. He is fighting foreclosure.

"No reasonable lender would have given him a loan like that," said Virginia Pratt, a foreclosure prevention counselor at ESAC, a Boston nonprofit group, who is seeking legal counsel for Rose.

Countrywide -- set to be bought by Bank of America (BAC.N) and seen by critics as a poster child for excesses leading to the housing crisis -- did not respond to a request for comment.

Rose's is an extreme case, but industry insiders say Option ARMs, also called Payment Option ARMs, will be the next chapter in the U.S. housing crisis and could push hundreds of thousands more subprime and prime borrowers into foreclosure.

"So far the public is largely unaware Option ARMs are going to cause problems," said Scott Stern, Chief Executive of Lenders One Mortgage Cooperative, whose 100 members originate $40 billion in mortgages annually. "But mortgage servicers know what's looming in the pipeline."

Subprime borrowers have weak credit histories, while prime borrowers have good credit. Industry insiders say a skewed system that paid mortgage brokers more to sell Option ARMs than traditional loans has left even prime borrowers struggling with monthly payments and unable to either sell or refinance.

"So far we have only seen the tip of the iceberg of this problem," said Michael Lefevre, CEO of trade group the National Association of Mortgage Professionals (NAMP).

NEGATIVE AMORTIZATION

Option ARMs have existed since the 1980s, but according to a U.S. Federal Deposit Insurance Corporation report, "Outlook Summer 2006," as recently as 2002 they were still quite rare.