When compared to the size of other mortgage categories like sub-primes and Alt-A’s, the total of Option Arms mortgages is relatively small at $750 billion. Still, at the current rates of default, percentage of homes under water, and speed at which the loans are becoming delinquent, these mortgages are some of the most problematic. They also make up a high percentage of loan modifications which require principle reductions to get payments back within reach of the homeowners that originally applied for them.

As prices accelerated during the last stages of the real estate bubble, Option Arms became an increasingly popular choice with borrowers because they allowed buyers to get around the loan to value and payment to income ratios required of prime mortgages. Records show that 83% of Option Arms written from 2004 to 2007 were stated income, also known as, liar’s loans. Income levels on these loans were typically overstated by approximately 50%

Sold under product names like “Pick a Pay” to mortgages got buyers into properties by keeping initial mortgage payments unrealistically low. In a standard issue Pick a Pay, borrowers could choose one of the following options:

* To pay the fully amortizing interest and principal
* Full interest with no principle payment
* An ultra-low, interest-only teaser rate of 2 to 3%. The unpaid interest of the teaser rate was added to the balance of the mortgage, increasing the mortgage balance on a monthly basis.

The last option of the three are the negative amortization loans (neg-am’s) that make up about 80% of the total of Option Arms issued. They continue to bury homeowners at an alarming rate. Because most of the loans were written at or near the peak of prices, approximately 73% of the properties with Option Arms are under water. The second issue with the loans is that they recast after 5 years and become fully amortizing. The recast can occur sooner if the Option ARM negatively amortizes to 110-125% of the original balance. The exact trigger depends on the terms of the loan. The average payment at recast increases by 63% from $1,672 to $2,725.

Kevin Stein, associate director of the California Reinvestment Coalition said of negative amortizing mortgages, “My sense is that many option ARM borrowers are in a worse position than subprime borrowers. They wind up owing more and the resets are more significant.” When announcing the Making Home Affordable plan in February, the Obama Administration’s guidelines appeared to be pointed directly at the homeowners with Option Arms but the government sponsored program are off to a slow start having executed “more than 10,000 but less than 55,000 loan modifications. Homeowners with recasts approaching would be much better served to retain legal counsel to modify this type of loan due to the predatory structuring of the loans and the likelihood that a principle reduction could play an integral role in getting monthly payments back in line with their current financial situation.