Mortgage Increases Blunted
By Nick Timiraos
The Wall Street Journal
March 29, 2010
The struggling housing market appears as if it will sustain less damage than expected this year from a spike in the monthly payments on hundreds of thousands of exotic adjustable-rate mortgages.
The number of such loans scheduled to adjust to higher payments this year has shrunk. Lower-than-expected interest rates, coupled with efforts to aggressively modify loans, are likely to mute payment shocks for some borrowers. Many others already have defaulted on their loans even before their payments adjusted upward.
"The peaks of the reset wave are melting very quickly because the delinquency and foreclosure rates on these are loans are already very high," says Sam Khater, senior economist at First American CoreLogic.
The housing market still faces enormous challenges, and a full recovery is likely to take years. The threat posed by resetting payments, Mr. Khater says, is "a drop in the bucket" compared to problems posed by the sheer volume of borrowers who owe more than their homes are worth, known as being "under water."
Still, for years, housing analysts have worried about the threat of an aftershock from a big spike in mortgage defaults from so-called option adjustable-rate mortgages, which require low minimum payments before resetting to sharply higher levels, and "interest-only" loans, for which no principal payments are due for several years.
Most option-ARM borrowers made minimal payments, so their loan balances grew. That sparked worries about what would happen when those loans "recast" and begin requiring full payments on larger loan balances, usually five years from when they were originated or when the balance reached a designated cap.
Option ARMs may be among the most likely to benefit from the White House plan, announced on Friday, to force banks to consider writing down loan balances when modifying mortgages. Until now, the administration's Home Affordable Modification Program, or HAMP, has focused on lowering monthly payments by reducing interest rates and extending loan terms to 40 years.
A separate program could benefit borrowers who are current on their loans but under water by allowing investors to refinance those borrowers into loans backed by the Federal Housing Administration. Investors are most likely to refinance the riskiest loans that qualify.
The majority of option ARMs are set to recast over the next two years. But the volume of outstanding loans has fallen sharply because many borrowers, prior to facing higher payments, received modifications, refinanced or defaulted. Option ARM volume peaked at 1.05 million active loans in March 2006. At the end of last year, there were 580,000 loans outstanding, according to First American CoreLogic.
Fitch Ratings estimates that nearly half of all option ARMs that were bundled and sold as securities were 60 days or more delinquent at the end of December, even though just 5% of option ARMs had faced recasts. Fitch estimates that another 7% have been modified.
"The default process has already hit something resembling a peak," says Christopher Thornberg, an economist at Beacon Economics. "How much higher can it actually go?"
The threat of defaults, to be sure, is not going away. It is likely to weigh for years on high-cost housing markets in California and other states that saw an explosion in option ARMs and interest-only loans during the housing bubble.
Today, more than three in four option ARMs are under water, according to Fitch Ratings, and one-third have a combined loan-to-value ratio of over 150%.
Another 500,000 interest-only loans will begin resetting in the next two years. Many have fixed rates and require interest payments only for a five- or seven-year period, then move to adjustable rates and require full principal and interest payments.
But because interest-rate benchmarks are currently so low, interest-only borrowers who face resets this year could see minimal payment increases or even decreases.
Nevertheless, interest-only loans are likely to stress markets for years because so many borrowers are under water and because payments will go up once interest rates begin climbing.
Martha Shickley and her husband, who own a four-bedroom home north of Los Angeles, decided to stop paying their interest-only mortgage last August because they figured they wouldn't be able to afford their payments next year, when their loan will reset. "We're paying expensive rent here on a home that might already be under water and certainly will be soon," says Ms. Shickley.
Ms. Shickley says she has heard nothing from her lender, J.P. Morgan Chase & Co., which acquired the loan when it acquired assets from failed lender Washington Mutual Inc. "They haven't even sent us the default notice," she says. J.P. Morgan declined to comment.
For now, she and her husband are living rent free, using the savings to pay off debts. They have applied to their bank for a loan modification, and they hope to pull off a short sale, where the bank will allow the home to be sold for less than they owe. "We're ready to move on with our lives," she says.
Markets increasingly are discounting the likelihood of a default wave from option ARMs because banks with big portfolios have aggressively tried to refinance or modify them.
Wells Fargo & Co., which inherited $120 billion in option ARMs when it bought Wachovia Corp. in 2008, says it expects just 528 loans to recast with big payment jumps over the next two years. Wells says it modified loans for some 52,600 borrowers last year that included $2.6 billion in principal write-downs. Most of those borrowers were put into loans that have five- or seven-year interest-only periods.
That won't completely fix borrowers' problems because they will face yet another reset, but it does buy them time. Late last year, banking regulators began telling banks that they shouldn't give borrowers interest-only mortgage modifications in most circumstances.
"There is no relaxing, really," says Brenda English, a homeowner in Reseda, Calif., who had her option ARM modified into a loan with three-year interest-only payments at 4.25%. Her modified payments are around $25 less than what she paid before, but she says she's worried about what happens in three years. "It's just throwing it up in the air and hopefully the market will be better," she says.
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