When I was describing options ARMs to my sister yesterday she couldn’t believe that any lender would be stupid enough to make such loans. I had to repeat it to her a few times before she kinda believed me.

Option ARMs allow borrowers to skip part of their payment and add that sum to their principal. Monthly payments increase after five years or once the loan balance reaches a predetermined limit, usually 110 percent to 125 percent. Introductory interest rates can be as low as 1 percent.

For the average option ARM borrower, payments will rise 63 percent, or an additional $1,053 a month, when their rates reset, according to a Sept. 2 report by New York-based Fitch.

Four out of the top five option ARM lenders are now out of business; Wachovia, Washington Mutual, Countrywide and IndyMac.

Number 4, Downey Financial Corp. of Newport Beach, California, has lost 97 percent of its market value since May 1, 2007. In the second quarter, 65 percent of it’s home loans were option ARMs. Good luck with that.

Beginning of the end for Wachovia

On a May 2007 conference call, Wachovia Corp.’s then-Chief Executive Officer Ken Thompson trumpeted the $24 billion acquisition of Golden West Financial Corp., a California lender that specialized in payment-option adjustable-rate mortgages.

“I think that 12 months or so from now people are going to look at the acquisition of Golden West as one that produced great success for Wachovia,” Thompson said.

Seventeen months later, Thompson is gone and so is Wachovia. After losing 82 percent of its market value since that conference call due to mounting losses on option ARMs, the bank was sold to Citigroup Inc. today in a deal brokered by the Federal Deposit Insurance Corp.

At the time I thought the Wachovia purchase was crazy and I’m no expert on the mortgage market.

I thought whoever sold Golden West to Wachovia would be like those guys that sold AOL to Time-Warner at the end of the internet boom.

The only explanation I can come up with is that option ARMs were crack cocaine for mortgage lenders.