This story was originally published in The Denver Post on October 1, 2006.
For retirees Patrick and Marilou Foley, a mortgage carrying a low 2 percent interest rate seemed an answer to their prayers.
Marilou wanted to move from their two-story Littleton home into a ranch-style home where she could better care for Patrick, a former schoolteacher in the early stages of dementia.
After failing to sell their home, the couple, in their 70s, wanted to refinance into a smaller mortgage payment so they could rent the home out. They also needed cash to deal with mounting medical bills.
“They told us we were sitting on a gold mine,” Marilou said of the brokers at Altus Home Loans, an Arapahoe County mortgage broker that provided the couple with an Option Adjustable Rate Mortgage.
Despite its name, the Foleys said their new mortgage left them with limited options and put them on a path to foreclosure.
Two months into the new loan, the minimum payment that they thought would be around $1,000 is closer to $2,074 when property taxes and mortgage insurance are added in.
Taking that minimum option will add more than $1,100 a month in unpaid interest back into their loan’s principal.
The variable interest rate they are being charged is above 8 percent, much higher than the 6 percent rate on their previous first mortgage. Once unpaid principal grows to 115 percent of the loan amount, their payments will rise sharply.
“It is going from bad to worse,” Marilou said. “I can’t eat and I can’t sleep. I am desperate.”
Stricter disclosure near
Colorado has had the highest foreclosure rate of any state since March, according to RealtyTrac, a California company that tracks foreclosure listings.
Option ARMs can take two to three years to trigger higher payment levels if only minimum payments are made. Some experts think the loan will fuel a future wave of foreclosures if home values remain flat or down.
Banking regulators, concerned that borrowers aren’t fully aware of the financial risks, announced Friday that there will be stricter disclosure and underwriting requirements to help better inform consumers.
A prepayment penalty on the Foleys’ loan means the couple can’t refinance within three years absent a hefty fee. And the cash they expected to receive never materialized.
But Marilou isn’t staying idle. She is talking to the Arapahoe County district attorney and trying to organize other borrowers into a class-action lawsuit against Altus.
Ferren Rajput, president of Altus, defended the loan his company provided the Foleys, saying it is saving the couple $800 a month from their previous mortgage arrangement.
Attorneys for the two sides are in discussions, limiting his ability to comment, he said.
“Our policy as a company is to handle our customer complaints in ample time and to try to resolve them,” he said.
Option ARMs, long popular in Britain, came to the U.S. in the early 1980s, when deregulation allowed lenders to offer the product to borrowers struggling with double-digit interest rates.
Borrowers in option ARMs typically have four payment options each month: a 30-year loan term; a 15-year loan; an interest-only loan; and a minimum-payment option that adds unpaid interest to principal – also known as negative amortization.
If underwritten properly, the loans are low risk and a good product for borrower and lender alike, said Herbert Sandler, chief executive of Oakland, Calif.-based World Savings, one of the first and largest providers of option ARMs.
But he also acknowledges that many lenders who have started offering the product in the past two years aren’t underwriting the loans properly.
Mortgage brokers and production lenders began pushing option ARMs hard after rising short-term interest rates made adjustable-rate mortgages less attractive.
As recently as 2003, fewer than one out of 200 new mortgages carried a negative amortization option, according to Loan Performance, a San Francisco company that tracks the payment performance of 50 million mortgages each month.
Through the first half of this year, more than one out of 10 new mortgages carried a negative amortization option. In Colorado, 6.4 percent of mortgages made in the first half of the year fit that category.
“The reason these loan products are so popular is that they create affordability, lower monthly payments and allow people to buy the expensive houses now,” said Mark Fleming of CoreLogic, a Sacramento, Calif., company that measures mortgage risk.
Fleming also considers them ticking time bombs.
The minimum-payment option, designed for when income gets tight, can become dangerous if used constantly.
About seven out of 10 borrowers use the minimum-payment option, according to investment bank UBS.
The unpaid interest is added back to principal. Once principal exceeds 110 percent or 115 percent of the original loan, the minimum-payment option goes away. Borrowers are then faced with a payment double or triple the minimum.
Sandler argues that qualifying buyers for option ARMs should not be based on minimum-payment amounts, as some newer lenders to the product are doing, but rather on the actual rates behind the loan.
Option ARMs complex
Newspaper ads and radio spots heavily promote option ARMs with starter or teaser rates of under 2 percent.
As with offers for 0 percent credit cards, consumers bite on the low “teaser” rates, only to find themselves in over their heads, said Patricia McCoy, a law professor at the University of Connecticut in Hartford and an expert on predatory lending.
“We are in this no-man’s land of outmoded disclosure laws that are really confusing,” she said.
Among mortgages, option ARMs are among the most complex and confusing for consumers to grasp.
Too many borrowers who take out option ARMs think they are getting a low fixed-rate loan and don’t realize that their principal will grow, said William Klaess, a vice president with American Guaranty Mortgage in Greenwood Village.
“In the documents are all the disclosures, but who reads all the disclosures?” Klaess said. “This is a license to steal.”
Klaess, who oversees a mortgage help center on behalf of consumer advocate Tom Martino, said option ARMs represent the biggest source of complaints he receives.
“This loan is a dangerous loan,” Klaess said. “I can see the storm clouds forming from the foreclosures that this loan is going to create.”
Rajput said that Altus borrowers are informed about the product and its features, including negative amortization. They also have a three-day period to rescind the mortgage if they change their minds.
“Negative amortization was never explained to me,” said Marilou Foley, who added that she would have ripped up the loan papers if she had understood that a prepayment penalty had been slipped in.
Foley, who broke her leg before the closing, said she was on pain medication when she signed during a closing done at her home.
Consumer advocates say two types of borrowers, now common targets for option ARMs, should not take out the loans – buyers stretching to afford a payment and seniors living on a modest fixed income.
“To me, it is per se unsafe to give a senior an option ARM,” law professor McCoy said. “They do not have the financial ability to weather that.”
Rajput disagrees. The lower monthly payments provided by option ARMs can give people on fixed incomes more flexibility, not less, he said. Washington Mutual, one of the largest mortgage lenders in the country, calls option ARMs “the right loan for retirement,” he said.
Last week, federal authorities filed charges against Rajput for $1.1 million in unpaid taxes related to a previous company. Rajput, who filed for bankruptcy protection in 2004, declined to comment.
Staff writer Aldo Svaldi can be reached at 303-954-1410 or asvaldi@denverpost.com.
