Reference no: EM133227683
Alan recently joined Friendly Investment and Financing Options (FIFO) as a loan officer. FIFO is a national company that specializes in mort-gage lending. One of Alan's responsibilities is to increase the total dollar amount of mortgages FIFO initiates. In a meeting he had with the CEO yesterday, Alan was told about a new mortgage that FIFO intends to market. The new mortgage is called a homeowner's option adjustable-rate mortgage, or an Opt ARM for short, and its most attractive feature is that homeowners can choose to make relatively low monthly payments at the beginning of the mortgage period. However, the payments increase significantly later in the life of the mortgage. In fact, depending on the amount the borrower chooses (hence, the term option) to pay at the beginning of the mortgage, the amounts that must be paid later could be substantial; perhaps as much as four to five times the initial payments. In many cases, when a homeowner chooses to pay the mini-mum amount or an amount that he or she can afford, the mortgage turns"upside down," in which case the amount due on the mortgage is greater than the value of the house.
The primary benefit of Opt ARMs to borrowers is that such loans allow those who cannot afford the monthly payments associated with conventional mortgages the opportunity to purchase houses. A borrower with income that is lower than is needed to qualify for a conventional mortgage can borrow using Opt ARMs, choose an afford-able (lower than conventional) payment in the early years of the mortgage, and then make the higher payments in later years when his or her income presumably will be higher. Thus, option ARMs permit those who can't afford conventional mortgages to buy houses today that they otherwise couldn't afford until years into the future.
Lenders such as FIFO like selling option ARMs because they can recognize as current revenues the monthly payments that would be required if the loans were conventional mortgages, regardless of the amounts that the borrowers opt to pay. In other words, companies can "book "revenues that will not be collected for a few years.
Unlike most people, including many professionals, Alan understands the complexities of Opt ARMs. He knows that many borrowers who choose such mortgages will lose their houses three to five years after buying them, because the payments increase so significantly after the low-payment option period expires that these borrowers cannot afford the new, higher monthly payments. And although they would like to refinance with conventional mortgages, often these homeowners do not have good enough credit to do so. This scenario is quite disturbing to Alan. He would like to explain to his customers in clear terms the possible pitfalls of Opt ARMs, but the CEO of FIFO has instructed Alan that he should provide only the information that is required by law and to follow company policy, which states that lending officers should provide basic printed material, give simple advice, and answer questions that might pro-vide negative information only when asked.
Alan has a bad feeling about Opt ARMs. He knows that they are great lending and borrowing tools when used as intended. He is afraid, however, that FIFO is more concerned with booking revenues than with the financial well-being of its customers (borrowers). What should Alan do? How would you handle this situation if you were Alan? Should the Opt ARMs be called HARMs (Hopeless Adjustable-Rate Mortgages)?
Read Ethical Dilemma: Which ARM Should You Choose - The Left or the Right?
What should Alan do?
How would you handle this situation if you were Alan?
Should the OptARMs be called HARMs (Hopeless Adjustable Rate Mortgages)?