The ‘Pay Option ARM Implosion’…Subprime’s Big Brother

Posted on April 30th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

The Wall St Journal just nailed the Pay Option ARM story. It is about time the mainstream picks up on this. In my opinion, this is the big one. ‘The Subprime Implosion’ may have been only the ‘pre-quake’ with ‘The Pay Option/ALT-A Implosion’ being the ‘big quake’ and ‘The Prime Implosion’ being a long series of scattered aftershocks. 

Don’t you love what the banks /ratings agencies consider ‘Prime’. I have said for a long time now that ‘the Pay Option Implosion will make the Subprime Implosion look like a bad earnings report because they cut across all socio-economic boundaries’.  Now the data are proving my point. This bailout will be the mother of bailouts. At least with a subprime loan, the balance does not rise each month (before the loan defaults), thank goodness.  Not so for Pay Options. 

The Pay Option ARM never should have existed. Unless values continue to rise, most of these loans will fail. This loan was never intended to hold for any length of time or for a declining value environment.

I did the video a few weeks ago with real data from the Fed comparing the total subprime vs. ALT-A universes. Click here or the link below. The ALT-A universe is much larger than the subprime universe in the higher priced states like CA and even nationally, it is somewhat larger.  But due to the sheer exotic nature of many ALT-A loans, such as the Pay Option ARM, the crisis will likely be that much more devastating. -Best, Mr Mortgage


Journal Story recap

-recent reports from mortgage securitizations suggest that subprime delinquencies have started going bad at a lower rate while delinquencies on option ARMs are speeding up.

-On Tuesday, Countrywide Financial Corp. said that 9.4% of the option ARMs in its bank portfolio were at least 90 days past due

-Unlike subprime loans, which went to people with weak credit, option ARMs were generally given to borrowers considered to be lower-risk.

Washington MutualInc. reported earlier this month that option ARMs account for 50% of prime loans in its bank portfolio, but 70% of prime nonperforming loans.

Wachovia Corp., non-performing assets in the company’s option ARM portfolio, which was acquired with the company’s purchase of Golden West Financial Corp., climbed to $4.6 billion in the first quarter from $924 million a year earlier.

Reference: Wall Street Journal

47 Responses to “The ‘Pay Option ARM Implosion’…Subprime’s Big Brother”

  1. Mark,

    If sub-prime is 1 Trillion and ALT-A is 50% bigger than Sub-Prime, what’s an order of magnitude seat of the pants guesstimate of the price tag for Pay Option ARMs?



  2. What percentage of these are in California?

  3. Open the pod-bay doors, HAL!

  4. Something WONDERFUL is going to happen!!

  5. blame yourselves

  6. Makes sense..when you give loans(like MTA’s) people based on the lowest tier payment…that increase principal each month..don’t you think that’s a time bomb waiting to happen to your “prime” borrowers???

    Already seeing it in my area where homes in the “country clubs” at 1 million plus are hitting the foreclosure arena…

  7. I love this product and so does a few of my clients. Here’s the real problem most brokers gave the borrower a high margin in order to get a HUGH rebate I on the other hand did not get a rebate and gave my clients a great margin 1.95 and with the current 12 MTA at 3.794 and dropping lower each month their current rate is 5.75%. The problem was not the loan it was the loan agent.

  8. I am a former AE from the central valley. If I recall correctly
    from 2005 to 2007 in the neighborhood of 70 of all transactions
    were pay option loans. I remember when we changed the name from Neg Am, which nobody wanted!!
    I never sold those loans, when the market shifted to the pay option and that was the only product my brokers wanted.
    I got out of the biz. I couldnt stand the delirious smile and glazed over look of a slimeball broker who had been in the business for ten minutes , already drove a ferrari, and was making 20 grand per loan because of the 3.5 rebate for leaving the prepay in the neg am.!!!!!!!!!!!!!!!!!

  9. Here is a great map of option ARMs that were provided and discussed by Mr Implode.

    I believe this map represents 2006 originations.

    Here are some other great links:

    The option ARM should have never been used under the recent guidelines. It is one thing for borrowers with 30% equity and fully documented incomes. 88% of O/As were originated in 2006 with stated income guidelines…WTF?

    Most subprime loan resets increase payments by 30-50%. Most option ARMs increase payments by 300% provided the borrowers were making minimum payments (most do)

  10. I agree that the greedy broker is to shoulder some of the blame for the way they sold the Neg-Am to the customer; however why would WAMU, Countrywide, American Home, Wall Street, World Savings, etc… provide the oportunity to buy up the margins to rediculous levels in the first place.

    The root of this problem does not lie in the brokers lap – they made the hay while the sun was shining, but the Banks and Wall Street provided the sunshine.

  11. Like I said last week.

    In what world is a person paying a neg-am payment every single month in a rapidily declining market considered to be current? Not in my world.

    The real story here is HOW MANY OPTION ARMS ARE PAYING THE NEG-AM OPTION RIGHT NOW??? That would be very interesting to find out, if it’s even possible to do so.

  12. This is a great loan if structured correctly. I sold tons of these in the ’80s when the margins were low and the teaser rate was only 1-1.5% below fully indexed so the magnitude of negative was much smaller. I had these loans on my own properies for 13 years (even during periods of price declines) and always made the minimum payment and my loan balances after 13 years were in the ballpark of where they would have been with a fully amortizing loan because during declining index periods, my payment didn’t fall as fast as the imdex (due to the 7.5% payment cap) and my loans were paying off faster than regular amortized loans. This was the way the products were designed to work and they worked beautifully. But, they don’t work well when the neg. am. is allowed to grow so fast because of the 1 to 1.5% start rates.

  13. ComeAt – 75 to 80% pay the min monthly payment.

    S. Laughlin – it is a top down issue created by the investment banks. Mortgage brokers/bankers cannot originate a loan unless one of them would buy it in the end.

  14. I agree with you SpiderMonkey..the question isn’t the tier payment itself but the ability to pay “above” the neg am amount..I agree how many out there are not paying what they should on this loan..but instead are just buying time…I would submit that unlike the years before..most are paying “only” on the neg am amount…

    Jeff…the problem is not that the loan itself is bad..but the “ability” for a borrower to fool themselves into the “I will catch up next month” is just too tempting for most…It’s like making the min monthly payment on your credit card..What does it really do for you?

  15. And the WSJ trots out the same old, tired story that the borrowers now say they didn’t understand the loan.

    Shouldn’t these people have been a little more sophisticated? One guy they interviewed used it to refi, so he already has had a mortgage. Not a total rube.

    These stories all make these loans out to be so complicated. They can be explained in one sentence: If you pay the minimum, you haven’t even covered the whole interest that month, so that will be added to your balance. What’s so complicated about that?

  16. Neg am loans can be structured to be good for many borrowers. Low teasers, super-short initial fixed-rate persiods, high margins, onerous prepay provisions, inappropriate indexes, and poor underwriting turned a good product into a ticking time bomb.

    P.S. Linda–Your description is wrong because it’s simplistic. Over time, a well structured neg am ARM will amortize even with the minimum payments. About half the time, the minimum payment will generate super-amortization (i.e., more than cover accruing interest)!

  17. it’s ugly . . . I came across a file recently where countrywide had charged the borrower a 4.5 margin on the neg am loan they put him in 2 years ago, and he had made the min payment for all of those 24 months. Come on, a 4.5 point margin??? Terrible.

  18. This product has been around for 20+ years and I still do not understand why borrowers sign on he dotted line. As it is I sold 3 (three) of these loans over a 12 year period. I warned each borrower including my brother who needed the loan (divorce) that this loan would and could cost them their house, I never wrote one with a pre pay and charged the borrowers up front.

    When i had my own shop, i never trained my lo’s to sell this loan, but when they left me for greener pastures (slime pools) they eventualy sold this product out of greed…

    Now that i look back at my 12 years i can sleep at night, i hope the people that sell this or sold this product on a large scale can do the same.

  19. While you present a lot of good information and will get no argument about Wall Street being full of sh**… you seem to be focused on one side of the paradigm-

    If Wall Street is dumb enough to make a $4,000,0000 loan to someone with no verified job and a 600 Fico score, they are going to lose money. Some of your rants seem to suggest that they have somehow “manipulated” or “taken advantage” of such a borrower, many of whom do not appear to be making payments on these loans. It seems to me that the “little guy” that took out these loans is the one who is screwing the banks, along with the average US taxpayer that will ultimately bail out these idiots in California and Florida…

    Repeatedly, you have stated that banks need to write off these home equity loans and restructure them with borrowers, but how about the more honest solution of forcing borrowers to pay back the money that they legally owe? Why should I have to repay my credit card debt, but some person with a million dollar house gets a “pass”.

    For that matter, how much have you drawn on your home equity lines/lines of credit? Do you have any incentive for banks to write this down and settle for fifty cents on the dollar? It would be a nice gig to take out a $500,000 home equity line and pay it back at $250,000…. If you’ve previously stated your reasons for writing such vehement and one-sided posts, my apologies, but you’d probably understand why a mid-western guy (living in a $110/sq. ft house with 20% down and modest income/no payment problems) is a little skeptical of your motives? (not that i disagree with your conclusions, mind you! 🙂 )

  20. pandora’s box has been opened so the rules have changed. The banks spent years gorging on loans of every shape and size to anyone with a heart beat. Now, everything is buckling and they are focusing their efforts on hiding the problems. I want a swift conclusion to all of this so we can get back to business. By hiding and lying they are dragging it out. Dragging it out will prove disasaterous as we have already seen. The only way to end this and end this now, is for everyone to come clean, banks to take their lumps and prevent further losses. The only way to prevent further losses and waves of defaults is to make homeowners right again. Plus that is cheaper in the long run. Discounting all notes by 25% accorss the board would be a very swift solution for example spread across thousands of banks. And I am not saying the home owners did nothing wrong here, but who is more to blame, the crack dealer or the crack user.

  21. Let me be very clear…This loan does not make sense for any client at any time!!! This “pick your pocket” loan is a huge Net Worth Killer. Any broker or loan officer who sold these loans should be ashamed!!! Don’t give me this BS about “using the extra cash to invest elsewhere” because it makes no sense!!! Everyone knows that the best investment anyone can make is to Pay Down Debt!!! The Neg Am Scam is over!!! It is now known as the “Broken Arm” loan. It was pushed on the public by greedy loan officers and lenders, and the gig is up. Anyone who sold even one of these loans is either too stupid to work in the industry or a scam artist. Shame on anyone who took advantage of this to make money.

  22. So what will be your response when the investments inside of 401k’s decrease with your across the board fix.

    What will US securities be worth on the World Market if we supercede all of our own laws and a multitude of international security laws by making the people of CA whole again.

    Now that would propogate a depression followed by papering your walls with our currency.

  23. I agree with Jeff. It was the loser mortgage broker who put 3.75 margins & 3 yr prepay penalties on their 1 loan funding a month. I have had the option arm on my house since 1992. It is the best loan if you have a good margin. My rate is 5.45 and is going down to 3.95. It was as low as 3.18%. Oh and the loan is over $1mil.

  24. Mortgageman85 – What Admin is saying is that it’s going to be a hell of a lot less costly both domestically and internationally to merely pull the bandaid off the wound giving eveyone an across-the-board principal reduction of 25%. What we’re doing now is having the government (Fed & Treasury) continue to bailout every major criminal bank and brokerage coming to them with a tear in their eye to the tune of hundreds of billions of tax-payer dollars (soon to be trillions), commodities going through the roof thanks to the hedge fund fu#%ing idiots (now leading to world hunger, civil war and strife), local city governments seeing record deficits in their tax base because banks will not paying the damn property taxes-insurance-maintenance of foreclosed homes, the highest oil prices ever, destroyed dollar, and on and on and on.

    Broaden your constricted “American Capitalism or Die” mindset Mortgageboy. You want to die, be my guest. but your ass isn;t taking me down with you. A bailout of the American tax-paying home owner is the ONLY SOLUTION TO THIS DISASTER. How do like them apples teacher?

    There’s a “RESET” for you….

  25. @ Scott: well said! When you figure a fully indexed rate of 8.00% or so and taxes of at least 15-35% on investment gains, you’d have to have one hell of a rtn.

    The loan could be great if it’s rolled out in a high rate environment with rates expected to fall, but they were rolled out/pushed mostly when the FED began to raise rates. Of course a 6 month arm could due just as well.

  26. Today the FEDS lowered another 1/4 point and I believe they are not done. This mortgage mess and the result it is causing still has an ugly head showing.
    I am just waiting for the the dollar to drop another 50%, inflation through the roof, commodities much, much higher. Emerging countries will eventually own the US. Too many stupid (home buyers) and greedy (bankers) people live here. This was doomed to happen sooner or later. Get ready for thr housing problem to get worse before it gets better.


  28. While greedy loan brokers and mortgage bankers were busy writing O/A and alt-A loans no one was complaining about the profits that were being booked by the accounting departments. Now these same banks including Citi, Lehman,
    WaMu, Wachovia etc. are running like scared rats to the Fed or diluting company stock. I say let these banks and brokerage houses fail. They smiled and partied as the profits were reaped let them cry as they stand in the unemplyoment lines.

  29. First you cut the arm, then the head.
    These things are a cancer. Are there a lot ARM’s like creatures in Spain and Britain too ? I think so.

  30. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  31. The Option Arm is a great product. If you don’t understand the benefits and the risk associated with the Option Arm then this is NOT the loan for you and I am happy you didn’t sell it!

    The Option Arm loan was about flexibility in pmts. As a Broker/L.O. it’s your job to convey the mechanics of the loan to the borr.(YOUR CLIENTS). As a lender you should have assessed the true risk. Investors were paid a high rste on return.

    Option Arms work for savvy Borrs. self empl,100% comm., sales and any other fluctuating income occupation. Borrs. should have had 6-12+ mo lq. assets. Life Cap 9.95%, and low margin @ 2.30 or less. The pmt based on worse case scenario. The min. payment was an “out” to avoid a late due to a short income month. it was not a pass to go out and incur more debt on a credit card or buy a car,or to simply spend more money you did’t have. Every month a statement was delivered from the bank displaying the exact amount of all 4 payments and the deferred interest you have incurred.If you paid minimum pmt and could never pay back the interest within that year; you did not have any business in that loan or home, you simply could not afford it. Deferred interest(neg am) is just like delinquent taxes, it just doesn’t go away.

    It would not have mattered even if they were in a 30yr fixed, They were in over their head at the signing.

    Greed made a complete circle when it comes to this one. Borrowers/Brokers/Banks and Investors.
    Borrower purchased on emotional attachment to the property and in denial about the fully index pmt, Brokers (some not all) collected max rebate,made a quick dollar(now have NO clients) Banks and Investors lost money. There are no true winners here, Great and terrible employees of brokers and banks lost jobs and homes.

    There are no winners in this circle of poop.

  32. I made a nice little bear spread on Lehman Brothers monday morning. Ok I am a little bit chicken. It’s a bear srpeard with 2009 leaps, but it’s just doing great. I really expect the shit to hit the fan after your US presidential elections.

    These S.O.B., like Paulson and Bernanké, will try to maintain these investments bankers alive by hook or by crook, at least till the election. Anyways it’s a limited bet, with great leverage and only a smallish amount of capital. I prefer it to shorting. There are soo much people short on banks, that it’s like looking for trouble. Real great investigative work on the king of morgages. I never knew how sloppy these people from Lehman were! Almost a joke. Incredible. BRAVO !

  33. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  34. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  35. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  36. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  37. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  38. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  39. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  40. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  41. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  42. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  43. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  44. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  45. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  46. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

  47. […] The ‘Pay Option ARM Implosion’…Subprime’s Big Brother […]

Leave a Reply

XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>