Option ARM Killed Bank & Homeowners; Why Didn't Feds Shut It Down Sooner?
A risky lending product called an option adjustable-rate mortgage initially helped Washington Mutual—and mortgage brokers, who were paid an especially high commission on these mortgages—make money.
Offering a “teaser” interest rate of 1 percent for exactly one month, the mortgage allowed borrowers to choose between multiple payment options on their loan statement. The problem was, the least-expensive payment option didn’t even cover the interest on their principal balance. Hence, homeowners were soon underwater as the total amount of the mortgage grew unless they selected one of the more expensive payment options, reports the Seattle Times in a lengthy article.
Soon the bank would require borrowers with growing balances to make much higher payments that they might not be able to afford, in order to get the loan back under control. Sometimes, though, this problem was temporarily solved when the WaMu offered a refinance into another option adjustable-rate mortgage at a lower initial payment, even if the homeowner didn’t have the income to cover the payments for long. Some who obtained option adjustable-rate mortgages in place of prior mortgages with more desirable 30-year fixed interest rates seemingly may not have understood the payment terms, since they didn’t make sense in the long run, the Times reports in the article, which is the second in a two-part series.
The first article, which was published yesterday, describes how the bank abandoned many of its traditional lending standards, even allowing borrowers to qualify for option adjustable-rate mortgage loans with little or no documentation that they actually had enough income to afford to repay the loan.
At least one WaMu employee, Renee Larson, blew the whistle on the company, reporting to the Florida attorney general’s office what she describes as a difficult-to-understand loan, the newspaper reports.
“I feel like they perpetuated fraud with my help,” she tells the Times. “It makes me very angry.”
Fay Chapman, the Seattle-based bank’s general counsel, said option adjustable-rate mortgages were a good choice for some borrowers. But because they could make so much money from issuing option adjustable-rate mortgages “mortgage brokers put people into the product who shouldn’t have been.”
Today, WaMu and the other major banks that made option adjustable-rate mortgage loans are either out of business or have been sold, the newspaper reports. Although the loans aren’t currently offered, there’s still no rule against making them.
It’s still legal for banks and mortgage brokers to put borrowers into the loans that make the most money, rather than those that make the most financial sense for the homeowner, the Times says. Rules have been proposed by the Federal Reserve Board that could restrict such profiteering, however.
And, starting in late 2005, regulators began asking banks to make more disclosures to borrowers and stop offering loans that homeowners couldn’t repay.
Related coverage:
ABA Journal: “The Bad-Debt Blues”
ABAJournal.com (2008): “AGs in 2 States Sue Countrywide, Allege Deceptive & Unfair Practices”
ABAJournal.com (2007): “Foreclosure: One California Home’s Story”
Seattle Times: “6 loans in 6 years: How one woman lost her home”
