San Francisco could see a sharp increase in foreclosures next year as 5 year option ARMs start to readjust
Thousands of Bay Area homes have a ticking time bomb embedded in their mortgage. The homes were purchased with loans known as option ARMs, short for adjustable rate mortgages.
Next year, many option ARM payments will begin to readjust, slamming borrowers with dramatically higher monthly mortgage bills. Analysts say that could unleash the next big wave of foreclosures - and home-loan data show that the risky loans were heavily used in the Bay Area.
That's because option ARMs let borrowers choose to make very low payments for the first five years. During that initial period, borrowers can pick their payment option - they can pay interest and principal, interest only, or a minimum monthly payment that doesn't even cover the interest.
Fitch said 94 percent of borrowers elected to make minimum payments only. The shortfall gets added to their loan balance, which is called negative amortization. The amount they owe can grow substantially.
In 2005, I considered buying a house. It was before I moved to New York, and I felt pretty settled in the Bay Area. But more than that, the housing market was exploding and it seemed like if I didn't buy property, I was missing out.
So my friend Aki and I looked at places in San Francisco, planning to split a 2 or 3 bedroom condo. We would get a 30 year fixed for 80% of the loan, and another 5 year option ARM for the rest. Who needs a down payment? We built financial models in Excel, and counted the profits in our heads.
But our math was clearly flawed. We assumed property values would keep going up, we assumed our interest rate wouldn't change, we assumed we would flip the house for a profit in just a few years. We were looking at interest only loans, little money down, and were going to extend ourselves to our financials limits.
Thankfully, we didn't do it. In 2005, people were putting houses on the market for 10% below the appraised value, to get 30 offers and sell the place for 30% *over* the appraised value. Unbelievable.
It was too crazy, even for us.
And now, 5 years later, it all comes back around. All those who did buy houses beyond their means might be in trouble next year when their loans adjust.
We're very lucky to not be in that boat.
