Subprime Reset Time

Do home buyers with reduced-payment option adjustable rate mortgages really understand the big monthly cost increases headed their way?

Major lenders who actively pushed option ARMs during the heyday housing boom years have now scaled back, and at least one is concerned enough about the coming payment "reset" dates that it has sent letters directly to thousands of borrowers.

Option ARMs -- wildly popular in high-cost markets in California, the Southwest, and the East coast during 2003-2005 -- allow borrowers to choose to make minimum monthly payments that are insufficient to pay the full interest due or to reduce the principal. When borrowers choose that option, their deferred payments are lumped onto their principal balance -- raising the debt they owe the lender higher than their original loan amount.

The other two options available to borrowers are a fully-amortized payment -- principal plus interest -- or an interest-only payment where no principal debt is paid off. Mortgage industry research has found that roughly 75 percent of all option ARM borrowers choose the minimum payment.

Many option ARMs are scheduled to reset to higher payments this year and next -- an estimated half trillion dollars worth during 2006 alone, according to mortgage giant Freddie Mac. Federal and state financial institution regulators, along with some prominent lenders, worry that not all borrowers now making minimum payments are aware of the size of the monthly payment increases they may soon face. Worse yet, some of these loans were made to people who were on the financial bubble to begin with: their credit was stretched to make even the minimum payments necessary to afford the house they purchased.