When 'good' mortgages go bad

A fresh round of mortgage misery is lurking in the suburbs: Beginning next year, hundreds of thousands of middle-class borrowers who have good credit will find that their mortgage payments are going up and that they owe more than they originally borrowed to buy or refinance their homes.

The culprit: Payment Option Adjustable Rate Mortgages, better known as option ARMs.

Option ARMs allow borrowers to choose how big a check they want to write each month -- from considerably less than the real bill to considerably more. Though meant to be a flexible payment plan for select few borrowers, they became widely popular during the latter stages of the housing boom, especially among builders looking to move unsold new homes.

Consumer advocates said the loans have been misused to add tens of thousands of dollars to the mortgages of many middle-class Americans, a pileup of debt that -- coupled with declining home values -- eventually will cost many of them their homes.

AARP has called option ARMs -- with their various payment options, fast-changing interest rates and periodic pay-up deadlines -- "time bombs for all but the most financially sophisticated." One industry analyst calls them "the most complicated mortgage product ever marketed to consumers."

By 2006, option ARMs had spread beyond the sliver of suitable borrowers to account for 6 to 8 percent of all new mortgages. In Minnesota, they accounted for 3.8 percent of loans statewide in 2006 and 4.8 percent in the Twin Cities, a tenfold increase in three years, according to data provided by First American CoreLogic.

Now, $400 billion in option ARMs are lighting up lender charts as the next wave of trouble after subprime mortgages. Borrowers' pushed-back balances will start coming due next year through 2012. If they can't pay, that money gets tacked on to their old loans, creating bigger loans with bigger payments. If they can't afford them, and if they can't refinance because of dropping home values, they face foreclosure.

Option ARM holders are unlikely to get help from any of the big mortgage-aid programs announced by the federal government and major banks so far. These are prime mortgages, so they are outside the current focus on subprime loans made to riskier borrowers. Also, because the defining trait of these mortgages is their steeply rising balances, the usual solutions -- such as freezing or dropping the interest rates -- don't help. Lenders would have to settle for less than the balances owed, the last thing they want to do, foreclosure counselors said.

Too many options?

Option ARMs give borrowers four payment options a month, the lowest being a "minimum payment" and the highest an amount that would retire the loan extra fast -- in 15 years instead of 30, for example.

That's the "option" part. It makes these good loans for people who have strong but irregular incomes -- such as salespeople who get periodic bonuses -- said John Mechem, spokesman for the national Mortgage Bankers Association.

Option ARMs also have adjustable interest rates -- the "ARM" part. Lenders say the feature lets people stretch to buy bigger homes, starting with low payments and then gradually paying more as their incomes rise.

But consumer advocates say many borrowers were approved based on their abilities only to pay those early monthly minimums. Also, they note that many option ARMs allow monthly interest-rate adjustments, meaning some borrowers face new, higher rates before they make their first payments.

Eventually, a day of reckoning comes. Some of the mortgages set it at five years; many set it at 115 percent of the original loans. For example, when a $100,000 loan builds to a $115,000 balance, the lender effectively issues a new loan for $115,000, and the process starts over.

Not everyone thinks these borrowers deserve a bailout. Many chose option ARMs knowing they were gambling that their incomes and house values would go up, and now they want to blame the lenders, mortgage brokers and industry analysts said.

"I think many borrowers were more than willing to take loans without really investigating the terms or appreciating the risk," said John Bancroft, executive editor of the industry publication Inside Mortgage Finance.

Borrowers' advocates, on the other hand, say the loans were also sold to the wrong people, which is predatory lending. "We've seen people on Social Security sold option ARMs, and for people on fixed incomes they make absolutely no sense," said Alexa Milton, at ACORN Housing in St. Paul, a foreclosure prevention agency.

John and Stella Ajibewa are worried about losing the Circle Pines home they built in 2005.

"This has been my personal dream," said John Ajibewa, who works the overnight shift at the downtown St. Paul post office. Stella Ajibewa is a nurse at Fairview Southdale Hospital in Edina.

In 2006, the couple, who have three sons, wanted to combine two mortgages into one. They applied for, and said they thought they were getting, a 30-year, fixed-rate mortgage for $346,000. They figured their good credit scores -- both are at around 750, an elite level -- would qualify them.

Soon Stella Ajibewa noticed their monthly balance went up -- not down; after 15 months it is $355,000.

"We didn't realize money is added back into our principal," John Ajibewa said. "When you hear it explained, you think you've got it. Then you get this whole lot of papers to take home and read that you can't understand."

Michelle Brousseau, who sold the mortgage, countered that the Ajibewas knew what they were signing.

Brousseau said she spent "numerous hours and days" explaining the option ARM to them. She pointed out that the Ajibewas complained about her to the state attorney general and to the Commerce Department, and neither chose to sanction her.

Like the Ajibewas, Dan and Tina Oestreich said they didn't know what they were buying when they refinanced their Hugo house with an option ARM in the summer of 2006.

They've been notified that their 115 percent trigger will hit in about 18 months, when they will owe $299,000 on what started as a $260,000 loan -- for a house that now appraises at about $275,000. After that, their minimum payment will go from $960 to $2,240, a 135 percent increase.

"Unless we get some help, we're not going to make it," Tina Oestreich said.

H.J. Cummins • 612-673-4671