Option, Adjustable Florida Home Mortgages: Risky, but Popular

Regulators are concerned about them - but buyers don’t seem to be.

We’re referring to option adjustable rate Florida home mortgages, types of loans whose popularity has soared during the first five months of the year.

An option ARM is an adjustable-rate mortgage that gives borrowers multiple payment choices each month, including a minimum payment, an interest-only payment and a standard Florida home mortgage payment. The loans often feature a low introductory rate that is used to set the minimum payment in the first year. Hence, the appeal.

Allure of these Florida home loans

Many borrowers have been attracted to these loans because of their low introductory rates, which have run as little as 1%. But borrowers who elect to make the minimum payment can be hit with a rising Florida mortgage loan balance. They can also face trouble down the road, when their monthly payment resets. Roughly 75% of borrowers with option ARMs are currently electing to make the minimum payment.

According to a new study by LoanPerformance, option ARMs accounted for 12.3% of mortgage originations through May, up from 8.4% in all of 2005. The study looked at loans sold to investors that buy mortgage-backed securities.

The loans’ popularity occurs as rising Florida mortgage rates are making them less attractive. Many lenders have boosted their introductory rates to 2% or more. Once the introductory period ends, the true interest rate on the loan can be more than 7%, well above the current 6.64% average rate on 30-year fixed-rate mortgages.

“It’s hard to know why anybody would want [an option ARM] in the current rate environment,” says Keith Gumbinger, a mortgage analyst with HSH Associates. Yet borrowers seeking to lower their monthly payments have few other choices. Given the narrow difference between short- and long-term interest rates, Mr. Gumbinger says, “there are very few products that … provide payment relief.”

Florida home loan problems

There already are signs that some borrowers who took out option ARMs are running into trouble. Foreclosure rates for option ARMs “are rising fast,” although they are coming off very low levels, according to a report issued last month by Credit Suisse Group. Option ARMs are going into foreclosure an average of 10 months after the loan is made, earlier than for other types of loans, and that is “a cause of concern,” the report stated.

Federal bank regulators have proposed guidelines for nontraditional Florida home mortgage resources that would require lenders to provide more disclosure, while tightening up their lending requirements. There are concerned that borrowers who take out these loans may not fully understand the terms and potential risks involved.

Despite their downsides, option ARMs have been particularly popular with borrowers who are Florida mortgage refinancing. They accounted for roughly 17% of refinance transactions nationwide through May, according to the LoanPerformance analysis, and nearly 37% of refinances in California.

Fewer people have been choosing interest-only mortgages, which allow borrowers to pay interest and no principal in the loan’s early years. Such mortgages accounted for 21.6% of loan originations, according to the LoanPerformance analysis, down from 26.2% last year.

Evidently, forty-year Florida home loans have replaced interest-only loans as the “affordability mortgage du jour” for borrowers with blemished credit records, says David Liu, a director in UBS’s Mortgage Strategy Group. Subprime interest-only loans have come under pressure from credit-rating agencies and bank regulators.

Overall, some of these options can be helpful sometimes. But there are better ways to improve your credit rating and receive approval on a safer Florida mortgage loan.