Option ARMs a housing hazard

Home values are slowly rising, and interest rates are still at low tide. But some analysts see a hidden reef that could sink the housing market: option-ARM loans.

Option ARMs are adjustable-rate mortgages that give borrowers the option to make minimum payments that don't even cover the interest owed, much less the principal. That unpaid interest gets tacked onto the principal, increasing the size of the loan.

But there's a catch: The optional minimum-payment period usually lasts five or 10 years. Because most of the option-ARM loans were funded from 2005 to 2007, the easy-term periods have started to expire.

In a wave cresting through the coming two years, most of the estimated 900,000 borrowers who have option ARMs will lose their ability to make these teaser payments, according to First American CoreLogic, a Santa Ana, Calif., real estate research firm.

"Unless option ARMs are restructured proactively, large proportions of them could end in foreclosure, leading to a potential double dip in housing prices in many California markets," said Paul Leonard, director of the Center for Responsible Lending's California office.

Others may be able to afford the higher payments but could choose to walk away. Median home prices in Florida have fallen more than 40 percent since the peak of the housing boom in 2006. That means many borrowers will face higher loan payments on homes worth substantially less than they were when they bought them.

Although the mortgages represent less than 2 percent of all home loans, they carry a total balance of nearly $300 billion.

The mortgages, once geared toward affluent borrowers with irregular incomes, were expanded during the housing boom to allow people with lower credit scores or other handicaps to buy homes.

OPTION ARM BASICS

Four monthly options: Fully amortized 15- and 30-year payments, interest-only payments and lower minimums that turned unpaid actual interest into principal.

A 7.5 percent annual increase in the minimum due, sending monthly payments more than 30 percent higher in the fifth year.

Actual interest rates that adjusted monthly and were based on one of a number of bank indexes.

Caps on how much time could pass and how high the loan balance could go before the full payment kicked in.