Option ARMs Leave Borrowers No Good Options

There are many people still holding Option ARMs, and the payment shock will be dramatic. Today, we will look at an example of the circumstances these homedebtors face.

76 CLEARBROOK 41 Irvine, CA 92614 kitchen

Irvine Home Address … 76 CLEARBROOK 41 Irvine, CA 92614
Resale Home Price …… $473,000


Me and my monkey
With a dream and a gun
I’m hoping my monkey don’t point that gun at anyone
Me and my monkey
Like Butch and the Sundance Kid
Trying to understand why he did what he did
Why he did what he did

We got the elevator, I hit the 33rd floor
We had a room up top with the panoramic views like nothing you’d ever seen before
He went to sleep in the bidet and when he awoke
He ran his little monkey fingers through yellow pages

Me and My Monkey — Robbie Williams

Many people who took out Option ARMs were sheeple doing what everyone around them was doing. Like Robbie Williams in Me and My Monkey, the sheeple followed a crazy lending industry on a rampage to pillage the US economy. We are still trying to understand why they did what they did. The lending industry was distributing toxic mortgages like candy to children, and now foreclosure fetch up soils our financier’s fancy suits.

Me and My Option ARM

Long time readers of the blog know my fascination with the connection between micro-economic circumstances and decisions and macro-economic results. We all know the Option ARM story, but there more to add to our collective knowledge.

One of the first attempts to explain Option ARMs from a borrowers perspective was right here at the IHB when Graphrix wrote the post, Mortgage Magma: The Coming Eruption of Option ARM’s. That post has a series of tables showing the many permutations of Option ARMs.

I recently found another great post on Finance My Money titled, “The New Mortgage Dynamics and the Anatomy of a Pay
Option ARM Borrower. 850,000 Option ARMs Still Outstanding and 40
Percent in Distress. 4 Reasons to Walk Away from your Option ARM
.” In that post, the author made the following observation:

Nearly 60 percent of these loans [Option ARMs] are in California. So a conventional look would estimate that 348,000 active option ARM loans are in one state. These loans also carry higher balances. Let us run
a hypothetical scenario to show how insidious this mortgage really is.
Let us assume that you bought in 2006 a $500,000 home in California.
This was the median price in 2006 and 2007 so not uncommon at all. You
decided to go with only 5 percent down but took out an option ARM.
Here is what your financial situation would look like:

option arm calculation

Source: Mortgage-Info

93 percent of option ARM borrowers went with the minimum payment.
So a $475,000 mortgage would cost you $1,939 a month. This is for
principal and interest. You still have taxes and insurance but let us
set that aside for the moment. Now looking at the above, you notice
that each year $10,572 is negatively amortized. That is, your actual
loan balance will increase. Now here is the interesting thing. The
actual term on many of the Option ARMs was five years or 60 months with the minimum payment. But many had
ceiling caps of 110 or 125 percent. In the above, we are assuming a
110 percent cap. So in fact, the borrower will hit a recast date in
the fourth year because of the negative amortization.

I think the example presented above is great because it is so real and easy to follow. It isn’t difficult to imagine thousands of borrowers here in Irvine facing these circumstances. There wasn’t much subprime here, but Option ARMs are common because people could reduce their housing costs so much by using them. It is too bad they are so toxic.

Do you know many people who can afford to have their house payment go from $1,939 to $3,708? Do you know may who will choose to do so when they are hopelessly underwater?

Take a good look at today’s featured property. It could probably be rented for the $2,000 a month it would take to cover the Option ARM teaster payment, but if the only option for keeping this property is to start paying $3,708 to stay there, would you? Could you?

The default rates on these loans will reach 100% because the only hope for
these borrowers to stay in their properties is a loan modification. IMO, that hope is one of a series of Bailouts and False Hopes designed to get borrowers to serve their masters and make a few more payments. If billionaires don’t feel guilty about walking away from debts, should houseowners? Many are walking away from houses they can afford.

The individual circumstances Option ARM borrowers face will force them out of their houses, and the collective impact will be many foreclosures, a flood of inventory and lower prices.

76 CLEARBROOK 41 Irvine, CA 92614 kitchen

Irvine Home Address … 76 CLEARBROOK 41 Irvine, CA 92614

Resale Home Price … $473,000

Income Requirement ……. $101,652
Downpayment Needed … $94,600
20% Down Conventional

Home Purchase Price … $445,000
Home Purchase Date …. 6/28/2006

Net Gain (Loss) ………. $(380)
Percent Change ………. 6.3%
Annual Appreciation … 1.6%

Mortgage Interest Rate ………. 5.33%
Monthly Mortgage Payment … $2,108
Monthly Cash Outlays ………… $2,870
Monthly Cost of Ownership … $2,330

Property Details for 76 CLEARBROOK 41 Irvine, CA 92614

Beds 3
Baths 2 baths
Size 1,115 sq ft
($424 / sq ft)
Lot Size n/a
Year Built 1980
Days on Market 8
Listing Updated 12/30/2009
MLS Number S599776
Property Type Condominium, Residential
Community Woodbridge
Tract Pv

Wonderful Standard Sale in fantastic neighborhood of Woodbridge with 3 bedrooms, 2 bath, Ground Level with Wrap around Patio, Laminate flooring in the living & family rooms & kitchen , Recessed lighting, Open Living/ family room, Separate dining room, Stainless Steel Appliances, Inside Laundry, Located in the heart of Irvine with excellent schools, A few blocks to the lake.

39 thoughts on “Option ARMs Leave Borrowers No Good Options

  1. NoWowway

    That is over $400/square foot. Too pricy for this type of starter home.

    No mello roos, but that property still has TWO associations to pay dues to each month. This is a WTF price for this apartment. I’ve been in them before.

    Thanks for the option arm summary form. VERY easy to understand and read.

    I can see where people would opt for this type of loan a few years back, in anticipation of house price appreciation and “of course” annual raises at work. With the added pressure of unemployment and job/career destruction forces in play, this strategy became mega toxic.

    1. Geotpf

      Looks like the condo is worth $360k, not $473k. I’m sure the owner needs full price to not have it be a short sale, though. He/she won’t get it.

  2. lowrydr310

    This may have been posted here before, but I just stumbled across it and find the whole situation interesting to say the least:


    $1.3M home? Six kids? Software engineer? There are so many things I want to comment on, however my new years resolution is to be more kind and respectful.

    “We have always lived within our means. It was close each month, like most people, but hard work paid off and allowed us to live in the home we desired, in a nice neighborhood.”

    There was a lot of Kool Aid going around in Southern California, but up North it was and still is much worse!

    1. priced_out

      Wow. They were asking for strangers to give them $42K so they can continue living in a house they couldn’t afford (even though they seem to think they were living within their means).

      I would really appreciate if some strangers would give me $42K. I would spend it on some living-within-my-means vacations.

      Hey, it’s only $42K, right? The banks got billions!

      1. AZDavidPhx

        They were asking for strangers to give them $42K so they can continue living in a house

        Imagine a renter setting up his own webpage asking for donations so he can continue renting his 1M dollar house and cranking out children 3rd World Style.

    2. AZDavidPhx

      Looks like he is going to have to go find a nice rental while he pays off all those medical bills.

      Nice touch there, toting out the children and all.

      These folks need to find some less productive hobbies!

          1. priced_out

            You know what this guy is showing off?

            Welfare babies.

            Except, it’s not food stamps he’s looking for. He wants to live in a million dollar house. He wants to live in a nice neighborhood (not with the filthy poor people) with nice schools (not the crappy inner city schools where the poor people should go).

            And he can live the dream, if only you would step up and support him.

            I think these people are the result of a decade of reality television. Everyone thinks they’re a bright gold star and not a gold-foil wrapped turd.

        1. E

          In his own words…

          “Everything was going just fine until the end of 2008. I was working at a startup company at that time, and supporting my family even though it has been very tight, money-wise, as long as I can remember, but I always try to do what’s best for my family and work as hard as possible to keep things moving forward. Towards the end of 2008, the financial markets crashed and crumbled, and the startup I was working at started to lose their investors. By the first few months of 2009, the company I was working for stopped paying its employees.

          Hey honey! Work stopped paying me! Let’s have ANOTHER kid because FIVE suuuure ain’t ENOUGH!!!

          1. priced_out

            Working for a startup, and you’re strapped for cash?

            That’s the definition of not living within your means. If you take risks, you have to be able to cover your losses. This guy should have been saving each month while his startup was paying him because the odds are better than 50/50 that the startup would STOP paying him at some point.

            If you aren’t storing up fat during the summer, of course you’re going to be cold in the winter.

            This guy thinks spending 42% of his salary on housing is living within his means. He’s actually got the nerve to complain that the bank’s “arbitrary” limit of 38% is too low.

            …And he would totally prove them wrong by paying off his mortgage, if he could only pay off this $42K that he owes them for the past couple of months.

  3. Stock Investor

    IMHO, there is nothing wrong with Option ARM. It takes $20 calculator and 4th grade math to estimate consequences. Not exactly rocket science.

    Banks were lending money to non-qualified dishonest borrowers, who never intended to pay back their mortgages. Why is another question.

    1. Lee in Irvine

      But were the borrowers really dishonest when the banks told them how to answer the question before it was asked.

      Just saying …

      1. Stock Investor

        There is conflict of interest between lender and borrower. Is it not obvious to everybody?

        1. Lee in Irvine

          Let me broaden that out a little further.

          The conflict existed between the bondholder and the borrower.

          1. Stock Investor

            Homebuyer has no friends at closing table. Ever buyer agent may lie if it helps to close deal. Nobody can be trusted.

            By the way, FRM can be abused just like Option ARM. I have seen similar scheme with 2nd silent loan (no payments for 5 years, then something set to explode).

          2. TACOSHARK

            100% Correct. Buyer has no friends at closing. Thats the real problem. What do you expect when you put fish in a shark tank.

    2. IrvineRenter

      My basic issue with Option ARMs is this (from The Great Housing Bubble):

      “Whenever lenders create new, “sophisticated” loan programs that require advanced financial management on the part of the borrower, both the lenders and the borrowers fall victim to the Lake Wobegon effect. Everyone thinks they have above average abilities when it comes to managing their finances. In reality, perhaps 2% of borrowers have the financial discipline to handle an Option ARM loan. Unfortunately, 80% of borrowers think they are in this 2%. The reason for this comes from the inherent conflict between emotions and intellect. Eighty percent of borrowers may understand the Option ARM loan (or think they do,) but when the pressures of daily life create emotional demands for spending money on one’s lifestyle, the intellectual knowledge that this money should go toward a housing payment is conveniently set aside. It is this 2% of the most disciplined borrowers who will cut back on discretionary spending to make their full housing payment. Everyone else will make the minimum payment, fall behind on their mortgage, and end up in foreclosure.”

  4. OrangeRenter

    That article is the best explanation I’ve seen, but most option arms had initial rates of 1-2.5 (he uses 2.75).

    Even if you modify these to 2% fixed (fully amortized), and the payment typically goes UP, and 2% is the minimum Obama mod rate with a stiplulation that the rate step-up to current market rates (5%) after a few years… Even the modified payment will eventually reach $2500+.

    Someone tell me again how these can be “modified”, when many liar-loan borrowers can’t even afford the “minimum” payment?

    1. Walter

      This is hearsay, so not sure if it is accurate. A friend at work says his friend just got a mod. To make it work, they locked the rate to around 3% for a 30 year term. That still did not get it, so they pushed around $150,000 of the balance into a balloon payment at the end of the loan. The balloon portion is interest free!

      If they are will to go to these lengths, they will make the taxpayers pick up a bunch of these toxic loans.

      It is so nice to be rewarded for living within my means 🙁

      1. OrangeRenter


        Not heresay. Sounds like mods I was doing before I quit.

        The reason I rant about option arms is even THAT payment will increase for OA borrowers, AND if it’s like most mods, it will step-up even higher (to 5-6%), eventually. So option arm borrowers are still f*cked. They should just foreclose already!

  5. Lee in Irvine

    Interesting comments from Doug Fabian (equities ETF guru) recent letter. Not that many of us don’t know this is upon us.
    Dear Fellow Investor,

    Wall Street tells you it’s the beginning of a protracted bull market and stocks look great.

    Don’t believe it. And whatever you do, don’t bet your portfolio on it.

    Look beneath the surface of the so-called recovery and you’ll see enough trouble brewing to make the subprime market meltdown of 2008 “look like a walk in the park.”

    That’s not just my opinion. That’s the conclusion from RealtyTrac, the nation’s largest foreclosure tracking firm.

    We just survived the worst years in history for foreclosures, but we may not be so lucky in 2010.

    Option adjustable rate mortgages are teetering on the edge of the abyss, with $29 billion recast higher at the end of 2009, followed by another $67 billion in 2010. In fact, Barclays Capital says, “We expect 81% of the option ARMs originated in 2007 to default.”

    Yet those headlines are buried while Wall Street blares out about corporate earnings that “are not as bad as expected” and “lower job loss numbers” that don’t feel very low to me at roughly half a million per month.

    And so unsuspecting investors are grabbing up cheap stocks, spurred on by Wall Street, and giddy with thoughts of a new bull market ahead.

    But you’re about to get a rude — and costly — surprise. If you continue down the path Wall Street is leading you on you could lose half your net worth.

    I will say this. I keep questioning myself about my positions in the market and my opinion on the economy/real estate.

    Question: Are the stock market/real estate bulls right and are they the true contrarians here?

    But then I realize markets are not rational, and then commonsense sets it …


  6. newbie2008

    Lots of the borrower really were told by the lenders that the borrowing was a wise decision and what numbers to place in the boxes. The borrowers believed that they were the smartest ones around because they were taught how to leverage and had the new car and houses to prove it. Too bad “wish thinking” wasn’t true. I was told in 2005 by a highly respected mortgage broker that home loans were available with a DTI of over 60% with my credit score. I could buy a house 10x my income using an option-ARM.

    There’s talk that Fannie and Freddie may want to used the return/refund provision with the banks for defective loans, toxic. I just see it as just talk to CYA in govt.

    I wouldn’t mind the situation that much if the inovatation didn’t repackage toxic loans as AAA rated loans-investment. If the investors/pension plans knew the risk and wanted to make toxic loans, they should bear the loss. But with toxic loans marketed as AAA loans, it looks like fraud to me. IMHO. Those that did the toxic repackaging were rewarded and the taxpayers/workers and middle class are made to pay for the mess. The lower class will be made to pay with lower wages/unemployement compounded by inflation. Pension will go under funded and then will go under. Favored on WS will be bailout, while small banks will go under.

  7. John

    2006: $445,000

    2010: $473,000

    This house still appreciates from the peak in 2006.

    Am I hallucinating or what? This is as if the housing bubble never crashed!


    Can’t wait for the days when Option Armagedon decimates Irvine housing like the Riverside/San Bernadino areas.

    1. Geotpf

      Comps indicate the condo is currently worth about $360k. It looks like the price was set by taking what the owner owes plus all selling costs, so they walk away owing nothing. Of course, they won’t get anywhere near the asking price. This will turn into a short sale which will almost certainly turn into a foreclosure and a REO listing. This might take a year or two, however.

        1. Geotpf

          Not yet. It’s not even really pre-shadow inventory if the owner is current on their payments (likely, since it looks like they are trying to get out cleanly (although they will fail)). But it’s likely to become such at some point.

    1. IrvineRenter

      $300K; yes. Another way to look at it is the premium is hovering around 200% instead of its historic 25%-30%.

  8. alles_klar

    I wonder if many people that took out option arms stashed away the difference between the minimum payment and the 30-year payment? I understand most people with option arms used them to get into the house, as the minimum payment is all they could afford. However, there may be some out there that could afford the 30-year payment, and even saved the difference.

    Back when I owned a home, a co-worker of mine urged me to refinance my 30-year into an option arm and cash out my down payment. He said that I could stash away the down payment and the difference between the minimum option payment and the 30-year payment each month in a safe investment. Once the loan was set to recast, I could refinance and, if I choose to, kick in all of the money I had saved up. According to my co-worker, I would come out well ahead by having the stashed-away money earning a reasonable return (he suggested putting the saved money in a CD each year that would expire at the time the loan was set to recast). I ended up selling the house, so never did look into whether the numbers worked out. I was also scared about interest rates being much higher at the time of recast.

    Looking back, I would have been in a much better position getting the option arm had I kept the house. With either loan, I’d probably be underwater now, or at least have lost the 20% I put down (I bought in ’04 and sold in ’06). At least I’d have more “options” going the option arm route: I could choose to walk away and have a good amount in savings to make up for the credit ding, or I could apply the savings to the balance and possibly refinance if I wanted to keep the house. A nice put option.

    (The above assumes banks continue their policies of not going after deficiencies in recourse loans.)

    Obvioulsy the option arm was a horrible product for the banks (and now taxpayer), but it could have been a great tool for the financially savvy.

    1. Gemina13

      Actually, the option ARM is a great tool for the fiscally savvy. Say you take out an OA loan. You make the interest-only payment for three months, and then you catch up with what you owe in the fourth month. Or you wait until year’s end, and then catch up the loan entirely. You get a fat interest deduction on your taxes for the year.

      However, it only works if you’ve actually got the money to do this. If you’re scraping up the minimum payment every month, and wondering if it’s going to be groceries or the light bill this time, then, no, the option ARM is definitely not for you. And it wasn’t for a lot of people. But they saw the minimum payment and started telling themselves, hey, things are looking good at work; maybe I’ll get that promotion and a raise, and I can swing it easier. Or, the lender says I can refinance in five years and get a lower payment, so all I have to do is make the minimum on time for the next five years. And they signed.

      This is why finance and taxes should be taught in elementary schools. People were woefully ignorant of just how deep into the pit of debt they’d fall with these OAs, largely because they spun illusions about how they’d make it somehow. “Somehow” should never be an option when it comes to your financial future.

      1. Lee in Irvine

        I understand what you’re saying, but come on, you know as well as I know, the typical OC family doesn’t have the financial discipline to manage one of these mortgages. The default rate on these mortgages is staggering.

        I’ve suggested that a stated income loan should be available to REAL self employed people, who put 20% down, and have stellar fico scores. However, these loans are designed for a small segment in our society. When we started allowing single middle school teachers to state their income at $100,000, that’s when the problems exploded.

        1. Gemina13

          Oh, it’s true the average American doesn’t have the financial discipline to handle an option ARM. These products never should have been used in place of a traditional mortgage to begin with. They have one purpose: to make money, in the form of interest deductions and, eventually, ownership of property that can be sold at a profit (in theory).

        2. JK

          Hey Lee..news flash..there are single middle school teachers that make $100k. I made close to that..though now I’m married.
          I get your point, however. Anyone remember the story about a crop picker making less than 20k a year that got a 600k house?

          1. Gemina13

            I don’t remember the crop picker, but I do recall the Target employee who signed for a $725K loan on a $19K salary. The lender put her down as earning $91K a year as a “store manager”; she was, in fact, a cashier. Of course she lost her house.

            The article was never clear if she and the lender colluded on lying on her application, or if she was one of many who were, in fact, told they could afford the house while the brokers were busy falsifying her application in order to win a fat commission for themselves.

      2. Pwned

        Yeah I agree – even though that sounds simple it’s really way beyond the savvy of the typical family juggling kids, cars etc. Everyone I know who took out an option ARM in LA did so because they desperately wanted to buy a house at or near the peak of the bubble frenzy. There’s no way they could pay more than the minimum. Now they’re all “waiting for the market to recover.” Poor souls.

      3. Geotpf

        I’ll bet the minimum payment on an option ARM was less than the cost to rent the same house. In that case, as a rental-alternative, I can see people doing it.

  9. alan

    My two cents….

    I wouldn’t have as much problem with Option Arms as long as the borrowers had to be Qualified at the 30 year fully amortized rate with 28% DTI. That way only people who could afford to make the full payment would have the option of making a partial interest only payment. Qualifing people for these loans based soley on the teaser rate and using 40% DTIs and liar loans was sheer insanity.

Comments are closed.