Is the next shoe ready to drop in the Housing market?

The Wall Street Journal is reporting that defaults on so called 'Option ARM' mortgages are rising fast.

As of December, 28% of option ARMs were delinquent or in foreclosure, according to LPS Applied Analytics, a data firm that analyzes mortgage performance.

Nearly 61% of option ARMs originated in 2007 will eventually default, according to a recent analysis by Goldman Sachs

This is sobering news and indicates the bad news from the housing market is far from over.

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An 'Option ARM' is typically a 30-year adjustable rate mortgage that initially offers the borrower four monthly payment options: a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment, or a 30-year fully amortizing payment. These types of loans are also called "pick-a-payment" or "pay-option" ARMs.

'Option ARMs' are particularly toxic because they allow the borrower to make a small minimum payment each month with the unpaid part of the monthly payment being added to principle of the mortgage outstanding. In other words, these mortgages are subject to severe negative amortization. The amount you owe on the mortgage loangoes  up each and every month.

Let's say, for example, that the monthly payment is set at $1500. The homeowner decides to elect the minimum payment (the option) and pays $1000. The unpaid $500 is immediately added to the mortgage's principle balance outstanding. It only gets worse. Not only does the amount owed grow each month;  this higher loan balance is immediately reflected in the next month's calculation. In effect, the option arm owner is borrowing more money each month and then ends up paying interest on interest. Sounds a little like loan sharking--doesn't it.

It is easy to see that the amount owed on an option ARM mortgage could grow fast. Imagine watching the amount you owe on your mortgage double over time as you sit back and make the minimum payment. Next, imagine what you might do when you see the amount you owe on your mortgage going up each month; while the value of the house in the market place is going down each month. Easy decision for many Americans--walk away, stop paying,  go to foreclosure.

Nearly $750 billion of option adjustable-rate mortgages, or option ARMs, were issued from 2004 to 2007, according to Inside Mortgage Finance, an industry publication. Rising delinquencies are creating fresh challenges for companies such as Bank of America Corp., J.P. Morgan Chase & Co. and Wells Fargo & Co. that acquired troubled option-ARM lenders.

Another example of Dumb and Dumber. Who is Dumb and Who is Dumber?

Original content: Is the next shoe ready to drop in the Housing market?