A group of state Attorneys General, including the Attorney General of Kentucky, have announced a settlement with Countrywide Financial Corporation. The settlement announcement refers to mortgages with "initial 'fixed' teaser rates" and to "pay-option adjustable rate mortgages." This raises a question: "Why did such exotic mortgage products even exist?"
If I ever heard an oxymoron, the so-called "fixed teaser rate" is it. I am convinced that some consumers signed up for ridiculously low mortgage rates, let's say an advertised "fixed rate" of 1.9% or 2.9% ('fixed" for maybe six or twelve months, that is!), without realizing that this was a "teaser rate" that failed to cover even the interest due on the mortgage. In these cases, the difference between the "teaser rate" payment amount and the real interest that was accruing on the mortgage was being added to the principal, and would result in a much larger payment at some future date. The future payment would have to cover both the higher rate of interest for the mortgage and a larger principal balance that was being built up by adding unpaid interest to the principal.
Why were such loans issued? Why were mortgage brokers paid even more to originate exotic products such as "fixed 'teaser rate' mortgages" and "pay-option adjustable rate mortgages" than they were paid to initiate traditional, straight-forward mortgages? Simply stated, I think it was because mortgage originators like Countrywide were able to put other people's money at risk (not their own money, that's for sure) while taking the loan origination fees off the top. These crazy mortgages were packaged and sold as part of the "securitized mortgage pools" that Wall Street peddled to investors who had not-a-clue about the quality of the debt they were buying.
"Teaser rates" might be fine on credit cards, where debt amounts are lower and people are not putting their homes at risk. But the "teaser rates" used to induce people to buy certain mortgages were too often sold deceptively and, in my judgment, should be prohibited entirely. "Interest-only" mortgages are bad enough. But these "teaser rate" mortgages, and the so-called "pay-option adjustable rate" mortgages, frequently pushed monthly payment amounts that didn't cover even the interest on the loan. The unpaid interest was then bundled into a higher principal balance, and a much higher monthly payment, when the loan "reset" at some future date. If people were even aware that this much higher payment would be coming somewhere down the road, they too often bought into the idea that they didn't need to worry about the future higher payment because they would be able to re-finance again before the higher payment took effect.
Needless to say, the wheel has fallen off of this wagon. It was doomed to happen from the start. "Fixed 'teaser rate' mortgages" and "pay-option adjustable rate mortgages" were all too similar to the world's largest Ponzi scheme that has fallen apart on Bernie Madoff and his investors. We're all now paying a price for wild and crazy stuff that went on while regulators, responsible journalists, credit rating companies, and many others appear to have been asleep at the switch.