Americans are continuing to find new sources of money. The latest is option ARMs (adjustable-rate mortgages), which offer different payment options, including repaying no principal and/or paying less monthly interest than is due. Year-over-year growth in option ARMs is more than 35%, according to a recent CIBC World Markets Inc. report.
This is a variation of the popular interest-only mortgages in which the borrower pays just the interest portion of the monthly payment, typically translating into a 15% decrease in monthly mortgage payments. Many of these are also ARMs. In April, 35% of the ARM mortgages sold by Fannie Mae were interest-only, up from 10% in early 2004.
There are a number of problems with these products. First, mortgage rates are expected to rise over the next year, which will push up payments on all ARMs. Second, when option ARMs and interest-only mortgages end, payments will soar as borrowers have to start paying full interest and some principal.
Interest-only mortgages accounted for 17% of all new U.S. mortgages in 2004, compared with about 2% in 2000 and 3% in 1995. What is really scary is the popularity of interest-only mortgages in cities in which house prices are high. In San Diego, Atlanta, San Francisco, Denver, Oakland and San Jose, more than 40% of mortgage originations last year were interest-only.
Another cause for concern is that subprime mortgages now account for almost 25% of all new mortgages. In the first quarter, a fifth of these were interest-only, compared with 6% a year ago.
And, finally, there is the probability that house prices will stop increasing and may actually drop.
All this is pushing the U.S. economy to the edge of a crisis. Consumers could find themselves unable to meet their bills, unable to take on more debt and forced to cut back on spending. With consumer spending accounting for more than 70% of GDP, this is a recipe for a recession.IE
ARMs may be a recipe for disaster
U.S. consumers could be crunched if mortgage rates rise and house prices drop
- By: Catherine Harris
- August 31, 2005 October 31, 2019
- 11:48