Posted on 06/22/2005 6:42:05 AM PDT by austinite
Rising interest rates will likely increase the payment shock risk for borrowers in the burgeoning U.S. option adjustable-rate mortgage market, which may lead to higher defaults and losses on option ARM pools compared to interest-only or hybrid mortgage pools, according to Fitch Ratings in its revised option ARMs rating methodology report.
Fitch's analysis of the option ARM product shows that the degree of payment shock risk and loan balance growth is largely determined by the initial teaser rate, volatility of a particular index, and balance caps.
"Payment shock risk is higher for option ARMs under Fitch's cash flow stresses compared to other products, but not by much in some cases," said Glenn Costello, managing director of Fitch Ratings. "The higher payment shock risk for the option ARMs is due to the minimum payment option that keeps payments low for up to five years, but then can result in a 'recast' requiring a much higher payment."
The payment may reflect a larger balance because of negative amortization, he added.
"The more affordable the mortgage seems at origination, the more likely the option ARM borrower will face difficulty making their loan payment when it is recast to prevailing rates. The borrower's risk of default is exacerbated in a rising rate environment," he said.
Fitch recently completed a historical analysis of more than 65,000 negatively amortizing loans from 1994 through last year to understand when and for how long borrowers choose to incur negative amortization and their likelihood to incur payment shock at recast. Fitch found that while negative amortizing borrower repayment patterns are indeed sensitive to interest rates, a fraction of borrowers continued to negatively amortize as they approached the five-year recast, which mitigates an RMBS pool's exposure to default risk over time.
Fitch also found that in recent vintages, borrowers exercised the other payment options, making interest-only payments in addition to minimum payments, as well as fully amortizing payments. Fitch's default modeling weighs the risks of borrowers making each payment type. The probability assigned to negative amortization versus interest-only versus full amortization reflects historical experience through several interest-rate cycles and various economic climates.
Fitch incorporated its research with a cash flow analysis using a formal interest rate stress protocol that is consistent with other interest rate sensitive products rated by Fitch within global structured finance to determine the degree of the negative amortization and the timing of reaching the loan balance caps. The results are factored into Fitch's market value decline and loss severity analyses for option ARM pools
"Borrowers who actively manage their finances, expect to refinance or move within a short time, or have the financial wherewithal to cope with higher payments will be less likely to default when the loan payments are recast to a higher payment than borrowers who look to purchase a home they otherwise could not afford with a 30-year fixed mortgage," said Suzanne Mistretta, director, Fitch Ratings.
It didn't take a genius to see this coming. Why would ARM users have payment "shock"?
This is the first that I've heard of negative amortization.
I assume this means that this is a loan where you pay less than the actual interest and the balance in rolled into a larger principle.
And guess who the first people all these folks will be running to for "help" when it happens??
That's right - the 'gubmint.
With fixeds at 5 to 6% why the hell would anyone go ARM?
Yup. How can you claim to be "buying" a house when your mortgage doesn't actually have you paying off the principle at some point in time?
The next mortgage product coming down the pike will be one where the lender accepts less than the monthly payment required under the terms of the note...in exchange for a pre-determined percentage of any future appreciation.
The lender will be a "partner" in the investment.
It's the only way other than negative amortization that people will be able to afford to buy homes in certain zip codes.
Because it could be the difference in owning a home in the neighborhood you want vs. the one you "qualify" for under Fannie Mae or Freddie Mac guidelines.
I have not researched it to see if it were true.
'Principal' - amount of money; head dude at school
'Principle' - code of conduct;law;fact of nature
'Capital' - money; seat of gubmint
'Capitol' - central building of state
'Compliment' - "Nice dress, babe!"
'Complement' - to add to, agree with, to complete
sheeesh learn the language
I happen to own a property that includes a life estate. Since the banks can not resell the loan to the Fannie Maes, etc., they have to keep it in-house. Therefore, they were not willing to go fixed rate. If you know of a lender that will give me a decent fixed rate on a property that includes a life estate, please let me know.
Had the INTERNET been in existance back in the early 80s, you would have seen the same stories. ARMs are nothing new. Balloon payments are nothing new. People have gotten themselves over-extended for years!
Quote: With fixeds at 5 to 6% why the hell would anyone go ARM?
Because that 1 to 1.5% differnce will allow the people to have the McMansion they really want right now.
Unfortunately these loans are quite popular with folks who can't afford a 30-year mortgage. I had a lender try to push one of these "option" mortgages when I refinanced earlier this year. Each month the borrower could opt to make one of the following payments:
Payment based on 15-year conventional fixed-rate loan (highest).
Payment based on 30-year conventional fixed-rate loan.
Payment of interest-only, based on 30-year conventional fixed-rate loan.
Negative amortization (lowest), with the difference between the payment and the interest due being added to the principal of the loan.
After 5, 10, or 15 years the "option" mortgage is converted to a conventional fixed-rate - at the future market rate - with a 25, 20, or 15 year term. This is when the people who have gotten used to making the minimum payments will be hit hard. They'll have no choice but to refinance, and they'll owe more on their homes than when they first purchased them.
Needless to say, I said no thanks and got a conventional 30-year loan.
What are you the thread police??
I don't know about the UK and HK, but it is true in Japan.
Yeah, and a foreclosure in 3 years when rates creep up. If the 1 or 2% difference is make or break, then I'll bet these people have no furniture.
I have an interest only loan with a five year fixed arm. The rate is adjustable thereafter, but I continue to pay interest only. Why did I opt for this loan? I only plan on being in my current home for four years (from the time I took out the loan) and because the rate for the first five was just about the same as for a 30 yr (due to a solid credit rating). The home is located in a desirable area where real estate has traditionally held value, even in severe down turns in the market.
Bottom line, it all depends on what makes sense for each home buyer.
I just read something on FR yesterday where some expert expects the Fed to begin lowering interest rates, possibly by the end of the year.
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