An Option ARM is a adjustable rate mortgage, a loan popular during the housing boom for its low minimum payments before resetting at higher costs later. This helped a huge number of home buyers in US take loans with very low monthly payments initially and which allowed them to pay less than even the monthly accrued interest thus resulting in a "negative amortization", which means that the unpaid portion of the accruing interest is added to the outstanding principal balance.
For example, if the borrower makes a minimum payment of $1,000 and the ARM has accrued monthly interest in arrears of $1,500, $500 will be added to the borrower's loan balance. Moreover, the next month's interest-only payment will be calculated using the new, higher principal balance.
"Shirley Breitmaier’s mortgage payment started out at $98 when she bought a three-bedroom home in Galt, California, in 2007. The 73-year-old widow may see it jump to $3,500 a month in two years"- Says Bloomberg. The reset occurs when the outstanding mortgage balance reaches a level of around 130-150% of the initial mortgage balance.
About 1 million option ARMs are estimated to reset higher in the next four years, according to real estate data firm First American CoreLogic of Santa Ana, California. About three quarters of those loans will adjust next year and in 2011, with the peak coming in August 2011 when about 54,000 loans recast, the data show.
This reset will lead to further foreclosures in US and will be a threat to the housing recovery. The more than 30-35% fall in the value of property will not help the borrowers to refinance their mortgage and thus the foreclosures are inevitable which will lead to a further slowdown in housing prices. This will also result in more write offs on the balance sheets of the large banks/ lending institutions as the payments are difficult to come across.
Thus the recovery in the US markets is a long way thing and hey don't think that we have decoupled.
For more information on Options ARM please refer to the following link: http://www.lynxbanc.com/optionarm.htm
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