CEO Makes Call on Pay-Option Loans: It’s Risky

Mortgage lender Countrywide Financial Corp. regularly warns customers about the risks of paying less than the interest due on loans offering that option. Now Chief Executive Angelo Mozilo is calling some of them personally.

Mozilo reached out to borrowers as part of a “little experiment” to understand the reasoning behind making only minimum payments on so-called pay-option loans, a practice that boosts the total amount due, the 67-year-old CEO told investors Wednesday in New York.

“What we’re finding out is that they’re pretty smart,” Mozilo said. “It’s like voters: Individually they’re sort of idiots, but collectively they seem to make the right decisions.”

The customers Mozilo spoke with were convinced their home values would continue to rise, more than making up for the added costs, he said. Pay-option loans can accumulate interest, or “negatively amortize,” until a cap or a set date is reached and the interest rate automatically rises. Mozilo said he wanted to know why customers were paying only the minimum.

“The answer was, ‘I’m doing it because the rate of negative amortization is less than the increased value in my house each month,’ ” Mozilo said. “The average age of our borrower is about 38 years old. They have never in their adult lives seen values going down. The concept is alien to them.”

Pay-option loans accounted for about 18% of the $220 billion in residential loans Countrywide extended in the first half of the year.