Word: optioning
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Bone-setting was a doctor's skill borne of necessity. In the days when any surgery meant great pain and usually an infection, closed treatment was the only sensible option. A good closed reduction still makes any bone doctor worth his salt proud. Walk up to some poor guy looking forward to a life of pain, deformity and stiffness, pick up his wrist, give it just the right yank and wham! he's cured. Makes you feel like Fonzi kicking the Coke machine. (See TIME's special report "How to Live 100 Years...
...good news, relatively speaking, is that these loans are very concentrated: about 75% of all option ARMs were written in California, Florida, Arizona and Nevada, with the vast majority of those in California. In that way, the option-ARM problem is localized. People living in Phoenix, Las Vegas and California's Inland Empire, which have high concentrations of option ARMs, can expect to see renewed downward pressure on home prices. But the trend won't spread nationally...
With the housing market as it is, borrowers will find few good alternatives for rescue should they run into trouble. The traditional response of refinancing into a more affordable loan is off the table for many homeowners, considering that property prices have plummeted. More than 85% of option-ARM holders owe more on their loan than their house is worth, a situation known as negative equity or being underwater. Typically, a refinance is impossible without the borrower having at least 20% equity in a house...
...lenders will recoup more by foreclosing (the test any loan modification must pass). A recent Bank of America Merrill Lynch study of loan modifications at IndyMac, which provided the template for broader modification efforts, found that about 20% of subprime loans had been rewritten, while fewer than 8% of option ARMs got reloaded. (See pictures of TIME's Wall Street covers...
...perverse way, option ARMs won't be as jarring to real estate because the system is numb to the pain. When problems first arose in subprime, homeowners and financiers alike were caught off guard. But since those early days of the real estate crisis, all sorts of loans have gone sour in large numbers, including plain-vanilla 30-year fixed rates. "Option ARMs don't have the monopoly on poor performance," says Amherst senior managing director Laurie Goodman. "It permeates the market." When the resets come, we'll feel it - but it won't be anything we haven't felt...