Why thinking the mortgage market crisis is merely a subprime issue can get you in trouble

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Last week in my podcast interview with Brian Brady we talked about Pay-Option mortgages. Brian had the best analogy that I’ve heard of yet when describing these loans; he said:

Pay-Option mortgages were handed out like aspirin in Southern California. Pay-Option ARMs aren’t aspirin, they’re oxycontin.

Many people that I’ve talked to have brushed off the mortgage crisis as a purely subprime phenomenon. They say "I don’t have a subprime loan." or "I’m not subprime." and discount the problem as irrelevant to them. What they don’t understand is that they are probably in a loan that is going to adversely affect them in the near future – either a pay-option negatively amortizing loan or an interest only loan with very little equity in their homes.

In two good articles about this the California Housing Forecast and The Mortgage Insider discuss the impact of pay-option loans recasting in the next five years. These loans recast when their principal balance equals 115 – 125% of the original loan amount. This accumulation is going on as we speak and is unabated. Couple that rising loan amount with decreasing home properties and you can quickly see where the problem is.

In a few years, when we’ve bottomed off of the housing bubble and these ARMs recast at 115-125% of their loan amounts many homeowners will see their equity completely gone. They will have no room to refinance out of their mortgages. These prime borrowers will be hit the hardest. Expensive areas like the coastal communities where large portions of loans are pay-options will feel the pain. Just because you have an 800+ FICO score doesn’t mean you can afford your mortgage payment quadrupling overnight.

Best bet if you have a pay-option or interest only loan? Talk to a mortgage professional now! You need to make a game plan for the next year or two to handle the loan you are in. Call me or email me and I will be happy to walk you through the mechanics of your loan, how much time you have before it recasts based on your monthly payment and interest rate, and give you some alternative options.

UPDATE: More pay-option shenanigans here.