Option adjustable-rate mortgages, which give borrowers a choice about how much to pay back each month. If they choose to make only the minimum payment on a regular basis, their loan balance can actually rise.
That is a problem, when home prices are falling. Merrill Lynch called option ARM's "ticking time bombs, that will start ticking louder next year. Estimates that losses could total $100 billion on top of the other $400 billion in losses on subprime and other mortgages."
With lending standards getting tighter, refinancing out of these option ARM's may be impossible.
In 2006, $255 billion of option ARM's were originated, up from $145 billion two years earlier. All of these loans are due to reset between 2008 and 2012. Peaking, in 2010-2011. A majority of those borrowers will owe more than their home is worth.
Example: Jirina Koy, a data operator and her husband, Savane, who is disabled, took out an option ARM in 2005 when they refinanced the mortgage on their 1,200 square foot home in Stockton, California, pulling out $60,000 in cash. Ms. Koy did not understand the terms of the loan, and that it carried a $12,000 prepayment penalty. Refinancing is not an option now. The balance on the loan has climbed to $357,000 from $336,000 while the value of their home has dropped to $250,000 or less. Their lender, Countrywide Financial Corp, has offered to freeze the interest rate on her loan at 5.25%, down from its current 8.5%, while requiring her to make payments of principal and interest.
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