this is an ethical question regarding options ARMs posed by myinsturctor:
Alan recently joined Friendly Investment and Financing Options(FIFO) as a loan officer. FIFO is a national company thatspecializes in mortgage lending. One of Alan’s responsibilities isto increase the amount of mortgages FIFO initiates. In a meeting hehad with the CEO yesterday, Alan was told about a new mortgage thatFIFO intends to market. The new mortgage is called an optionadjustable rate mortgage, or an option ARM for short, and its mostattractive feature is that homeowners can choose to make relativelylow monthly payments at the beginning of the mortgage period.However, the payments increase significantly later in the life ofthe mortgage. In fact, depending on the amount the borrower choosesto pay early (hence, the term “option”), the amounts that must bepaid later could be substantial—as much as four to five times theinitial payments. In many cases, when a homeowner chooses to paythe minimum amount or an amount that he or she can afford, themortgage turns “upside down,” which means that the amount due onthe mortgage grows to an amount that is greater than the value ofthe house.
The primary benefit of option ARMs to borrowers is that suchloans allow those who cannot afford the monthly payments associatedwith conventional mortgages the opportunity to purchase houses. Aborrower with income that is lower than is needed to qualify for aconventional mortgage can borrow using option ARMs, choose anaffordable (lower than conventional) payment in the early years ofthe mrotgage, and then make the higher payments in later years,when their incomes presumably will be higher. Thus, option ARMspermit those who can’t afford conventional mortgages to buy housestoday that they otherwise couldn’t afford until years into thefuture.
Lenders such as FIFO like selling option ARMs because they canrecognize as current revenues the monthly payments that would berequired if the loans were conventional mortgages, regardless ofthe amounts that the borrowers opt to pay. In other words,companies can “book” revenues that will not be collected for a fewyears.
Unlike most people, including many professionals, Alanunderstands the complexities of option ARMs. He knows that manyborrowers who choose such mortgages will lose their houses three tofive years after buying them because the payments increase sosignificantly after the low-payment option period expires thatthese borrowers cannot afford the new monthly payments. And,although they would like to refinance with conventional mortgages,often these homeowners do not have good enough credit. Thisscenario is quite disturbing to Alan. He would like to explain tohis customers in clear terms the possible pitfalls of option ARMs,but the CEO of FIFO has instructed Alan that he should provide onlythe information that is required by law and to follow companypolicy, which states that lending officers should provide basicprinted material, give simple advice, and answer questions thatmight provide negative information only when asked.
Alan has a bad feeling about option ARMs. He knows that they aregreat lending/borrowing tools when used as intended. He is afraid,however, that FIFO is more concerned about booking revenues thanabout the financial wellbeing of its customers (borrowers).
