Mortgage crunch
People who finance their homes with ARMs may not realize the risks involved and often find themselves in serious financial situations as a result.

Business Report
Mortgage crunch
People who finance their homes with ARMs may not realize the risks involved and often find themselves in serious financial situations as a result.
By Stephanie Riegel , Contributing writer

When Louisa Spears, a single mother of three, bought her house near Greenwell Springs Road two years ago, the home loan her mortgage broker suggested sounded too good to pass up, especially given her limited income: She only had to put down $3,800 on an $85,000 loan. Better still, her monthly note was just $595.

Problem was, Spears didn't understand--or perhaps wasn't properly informed--that after two years, her note would jump 30% and keep climbing every six months after that. When that increase went into effect earlier this year, Spears panicked.

"I took on a second job to pay the difference," says Spears, who works in environmental services at Ochsner Hospital by day and now moonlights cleaning up for the East Baton Rouge Parish School board.

Spears is not alone. In recent years, homeowners both locally and nationwide have embraced lending products such as option adjustable rate mortgages (ARMs) that allow borrowers to make a minimum monthly payment and interest-only mortgages, which pay down interest only in the loan's early years.

But while these mortgages are attractive on the front end, the downside comes when the monthly notes suddenly shoots up, which typically happens after two or three years, or when a so-called balloon payment comes due at the end of a certain period.

That's happening now to homeowners like Spears, who embraced option ARMs when they were widely introduced three years ago. Now, with rising interest rates, higher insurance costs, tougher minimum payments on credit cards and skyrocketing utility prices, it's getting to be a real problem.

"The balloon rates are killing people," says Lyle Harmon, manager of Consumer Debt Counselors, a credit counseling agency. "I've seen a tremendous increase in the number of people I've had to counsel this year."

Harmon, in fact, is so busy he's in the process of hiring another credit counselor to handle the influx of debtors who come seeking help. While he can't say for sure how many of his clients' troubles are attributable solely to their mortgages, he is certain option ARMs and similar products are fueling the fires of overextended homeowners.

"All of a sudden these notes shoot up, and people can't afford to make other payments," he says. "I think they're terrible."

But they're popular, particularly with low- and middle-income buyers who might not otherwise have the means to purchase a home. With an option ARM, borrowers have four payment options: They can make a minimum monthly payment, an interest-only payment or a fixed payment on a 15-year or 30-year mortgage. A couple of years ago, those introductory rates were as low as 1.5 %. Since then, they've doubled in some cases.

"The more hybrid ARMs were very attractive, but they're also very volatile," says Terry LeBlanc, a mortgage broker with Acadian Residential Mortgage. "That's where people are having problems."

Kim Williams is one such example. The day-care owner and mother of three put down $5,000 on her 1,800-square-foot home near Howard Park two years ago, leaving her with a $74,000 mortgage and a $664 monthly note. Recently, that note jumped nearly 25% to $822, taking her quite by surprise.

"We were under the impression we were on a fixed mortgage, then we got this piece of paper in the mail telling us it's going up and that it's going to keep going up," Williams says.

To make up the difference, Williams is cutting back on some of her business costs in order to generate a little more cash to cover her expenses. She's also in the process of trying to refinance her home, something others are attempting as well, with varying degrees of success.

Harmon says many of his clients are trying to refinance, despite the hefty penalties they have to pay. Still, some don't seem to understand the ramifications of what they're doing. Instead, they want to jump from one low-interest product to another.

"I had a guy in here the other day, and I had to explain to him that you can't keep refinancing every two years," Harmon says. "The value of your house isn't going to keep going up every two years, and your note isn't going to keep going down."

That's a difficult lesson for a society of consumers who live beyond their means, say some experts. Consumer bankruptcy attorney Jimmy Herpin believes the trouble some are now experiencing with option ARMs or interest-only loans is symptomatic of a much bigger problem.

"We have a culture that has become dependent on financing everything," Herpin says. "Let's just finance it, and if somebody tells me I can afford it, I'm going to just do it."

Lenders don't help. Some are surprisingly lenient when it comes to how much they're willing to lend. Herpin recently shopped around for a mortgage to buy a new home, visiting several banks in the area.

"They said I could afford twice the note I knew I could afford," he says. "I know better than that. I don't know what their standards are. It's backward."

Not all mortgage brokers are eager to get their clients in above their head, however. LeBlanc's firm counsels borrowers very carefully, especially before writing them a mortgage they may default on in a couple of years or less.

"We try to steer them to an avenue that's going to be beneficial for all parties involved," LeBlanc says. "If it's a young couple or a salaried employee making $60,000, we're not going to put them [in an option ARM]."

Not all homeowners are fortunate enough to encounter a scrupulous lender, however. They're the ones now feeling the pinch. For some, it's too late. Because borrowers agree to the terms of their mortgages with their signatures, they have little recourse when they get into trouble. What's more, bankruptcy laws prohibit varying the terms of a mortgage.

"There's not a whole lot we can do in the bankruptcy arena," says bankruptcy attorney Darren Johnson, "except surrender the house."

Which is why Johnson thinks option ARMs and interest-only loans are a really bad idea for all but the most savvy investor.

"I would never recommend them," she says. "An interest-only loan is a way to qualify someone to--quote, 'buy a house'--who really can't afford that house."
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