Monday, September 24, 2007

Option ARM is the Best Loan: NYU and Columbia Economists Report

Business Week has a interesting piece on a recent study reported by economists at NYU and Columbia. They argue that in a "perfect world", where borrowers made educated, rational decisions, Option ARM programs would give the greatest benefit to both borrowers and lenders.

Interestingly enough, the Option ARM products for years existed in the mortgage industry as a niche product for the wealthy and sophisticated. Only recently, did they become utilized as vehicles for irrational behavior by the masses. Imagine, the authors suggest, how great it would be for all if consumers were rational, educated and prudent.
If the optimal loan really is better for homeowners who behave rationally, maybe it makes sense to get people to behave rationally through extensive, even expensive, consumer education. In an interview, Piskorski told me that by his rough calculation, the benefits of the optimal mortgage vs. a conventional mortgage amount to a least half a percentage point of interest—namely, $50 billion or more a year for the U.S. as a whole. In other words, you could devote many billions of dollars a year to consumer education about these misused-but-potentially-valuable loans and still come out ahead.

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