Posted on 01/04/2006 8:46:59 AM PST by Travis McGee
The HeraldTribune is reporting the clock is winding down on the Hybrid Loan and Sub-Prime mortgage time bombs.
Starting in 2006 and accelerating into 2007, as much as $2.5 trillion worth of the fancy mortgages called "hybrids" are coming to the end of the free-lunch part of the deal. Economists are still trying to put numbers on this reset factor, particularly when it comes to the riskiest home loans, referred to as "sub-prime."
"We don't have enough data to know how big a problem this will be," said David Berson, chief economist at Fannie Mae, the nation's largest mortgage packager.
The ticking clock.
Sarasota's John Barron is typical of the new crop of homeowner-investors. He and his wife, Lauren Wood, are sitting on big profits at two 2004 purchases in the up-and-coming Gillespie Park neighborhood, close to downtown Sarasota.
But the couple made their big moves using ARMs that are about to be reset. If they don't act soon, their monthly bills will rise by hundreds of dollars per month. They used two separate three-year, interest-only, adjustable-rate mortgages from SunTrust Bank to buy the homes within the past two years.
"Besides the two ARMs, we also took out a home equity line on the Seventh Street house to put down a deposit on the Fifth Street house. There was no cash that we had in our pockets to put down on the Fifth Street house. All we had was our shining credit record. And the faith that the banks have in this real estate market that allows you to borrow 100 percent."
Barron and Wood have a lot of company, says Paul Kasriel, chief economist at Chicago-based Northern Trust.
With possibly $2.5 trillion in household debt that is going to be repriced higher "the household debt-service ratio is bound to climb to new highs," Kasriel wrote last month. "Asset bubbles are characterized by cheap credit. Usually what bursts a bubble is higher cost of credit, because that is what inflates the bubble, is cheap credit."
At Sarasota's Integrity Mortgage Group, ARMs have far and away taken over as the most popular. Five years ago, there was only an occasional one-year or five-year ARM. "Out of 200 loans you'd do 10 adjustables," Integrity President Jason Thurber said. "In the last year, I've probably done five fixed-rate loans, 30- or 15-year, out of 150 loans. So all the rest are some kind of hybrid."
The big picture looks similar, says SMR Research of Hackettstown, N.J., which regularly surveys lenders who make 90 percent of America's home loans.
"I can say that the first half of this year, ARM share was 55 percent nationally," said SMR's George Yacik. "For the full year 2004, it was 50 percent." Making matters worse, it is the the sub-prime lenders issuing the most adjustable-rate mortgages. With those who participate in the survey, 80 percent of their loans were ARMs compared to 55 percent in the broader market.
Fannie Mae looked at 2002-2004 loan data to determine what portion of the existing loan pool would be "adjusted," and when. Fewer than 10 percent of the conventional conforming loans will reset in 2006-2007, but nearly two-thirds of sub-prime loans will. That is because a large portion of the sub-prime loans are two-year adjustables, says Berson, the Fannie Mae chief economist.
Berson offered a typical example of what the industry calls a "2-28," an ARM in which the interest rate is fixed for the first two years and then adjusts regularly for the next 28 to whatever index the loan calls for. The average yearly cap on this loan is 2.3 percentage points per year.
Roughly speaking, a consumer's monthly bill could rise from $330 to as much as $1,425 to $1,755.
Fannie Mae expects sub-prime loans to be reset en masse this year with that trend continuing into 2007.
But over at the Mortgage Bankers Association, senior economist Michael Fratantoni is more interested in the five-year adjustables that were issued during the refi craze of 2002-03. That's a large crop that will sprout in 2007.
"The estimate is that in 2007, more than a trillion dollars worth of hybrids are going to hit their first reset date," he said.
That one chunk of hybrid loans represents 12 percent of the $8.8 trillion in single-family home loans outstanding nationwide.
Like many ARM borrowers, Barron, the Gillespie Park buyer, is not really sure how much his payment will go up when the loans are reset. The new rate is a moving target. "Come year four, they adjust it based on the prime rate," he said. "It is like prime rate plus two, or, I can't remember exactly what the adjustment is."
At Washington Mutual's Bee Ridge Road office in Sarasota, 25 percent of current applications are for option ARMs, says senior loan consultant Mike Bangasser.
For customers with good credit, there is only about a half-percentage point difference between the 5.75 percent rate on an option ARM and the 6.375 percent rate on a 30-year fixed rate mortgage.
So why bother with the ARM?
This is the key: The minimum payment today on a $200,000 option ARM would be only $678, a little more than half the cost on a 30-year, fixed-rate loan. On that $200,000 loan, a 30-year fixed would be $1,248 per month in principal and interest. With the option ARM, there are three other payment choices: $958, $1,167 or $1,661.
The $678 payment doesn't even cover all the interest, Bangasser acknowledged.
He guesstimated that if somebody borrowed $250,000 on a typical option ARM and made minimal payments for five years they would be "going to be in the hole 15 percent to 20 percent of your original balance, meaning $285,000 to $300,000."
"You don't have to have negative am," Grande said. "As long as you make that fully-indexed payment, you're fine. But most folks aren't doing that. They take the easy way out, get themselves in trouble."
There is one more ingredient to add to this layer cake, and it is one that barely occurs to most borrowers today: What if someday, loans were difficult to get?
"Consumers have become so accustomed to very liquid mortgage markets, where credit is available for almost any circumstance, that they are not aware this is unusual in the market," HSH's Gumbinger warned. "Somewhat tighter credit availability and somewhat higher interest rates are much more normal."
"Borrowers think they can always refinance. That is not always a safe bet."
It's hard to know where to start with this kind of nonsense. But people still insist there is no bubble. That this type of activity occurs routinely is clear evidence of a credit lending bubble. Given that the credit lending bubble has grossly affected home prices, it should be obvious there is a housing bubble as well. Day in and day out however, someone writes an article telling us why this time is different and how affordable housing really is.
We have been talking about a possible "credit event" when these loans reset, so I guess we do not have much longer to see. It may not be a "big bang" however, as these loans are scattered throughout 2006 and 2007.
It is amazing to me that people in these loans are nearly clueless as to what their loans might get reset to. Barron's loan adjusts to prime rate +2 or something like that but he "can't remember exactly what the adjustment is." Yikes that is 9.25%, on three properties! He has three 100% loans based solely on "shining credit" and someone stupid enough to make the loan. Perhaps a better way of stating it is some hedge fund or mortgage player or investor is stupid enough to take that risk for perhaps an extra 1/4 point or 1/2 point over treasuries. Is that a good deal? I think not and I fully expect to see some hedge funds and/or leveraged reits to blow up over it too.
January 1, 2006 Mike Shedlock "Mish"
For your possible interest.
I did a 5/1, but only because I'll have the balance paid off in 5 years or I'll have moved.
I did a 3/1 ARM at 3% two and a half years ago. I knew I would be out of the home before the adjustment period started. Sold the house last week.
Yada, yada.....
I got a 3/1 Arm, 1 1/2 years ago at 3.5%.....
So I got a very low payment, I got accelerated principal payment, in year 4 it can only rise to 5.5% (still below current market rates) and in year 5, if I want to I can refi.
So no thanks, I'll keep the ARM.
The old ARMs aren't the problem, it's the interest-only part that's the problem. People are "buying" homes with interest only loans but are essentially renting them.
When most people got their ARMS (1 to 4 years ago), the ARM rate was dramatically below fixed rates and there was tremendous advantage to them. However, today, it is not unusual to ARMS with the same rate as fixed or only .25% below a fixed rate. No big advantage to ARMs currently.
Please add me to your ping list, thank you.
The fed is hinting that they are leveling off on interest rate increases. So ARM's don't look like they have a huge upside coming. In the mean time ARM holders have been able to pay off more principle than fixed raters.
that was my idea. i got a much lower interest rate to go with an intrest only arm. so i regularly pay over the minimum to work off the principal faster.
Did you actually read the article? You are making a hell of an assumption there.
It's gonna be fun watching all those folks all rushing to the door at the same time, trying to sell their homes. Gee, I wonder what's going to happen to the prices?
It's a very low-volume ping list, maybe once a week.
I've also got a 2nd Amendment ping list and a Civil War Two ping list. Do you want to be on them as well?
Yep. They have no clue. Folks have negative amortization loans, and don't even understand the concept.
Please, thank you.
"No big advantage to ARMs currently.
"
That can be true, except they're still peddling the interest-only option on these, leading the buyer to wrongly think they can afford a property they should probably avoid.
If I were one of these folks, I'd be looking closely at what the payment's likely to be when the loan converts, then either refinance now or plan a sale at least 6 months in advance of the conversion date. To be safe, 9 months would be better.
The young couple who bought my former house in California financed it this way, against my advice. Trouble is that now there's a problem there. The sewer that was supposed to be built in that small coastal town is stalled, and there are a bunch of lawsuits and regulatory fines looming.
Homes in that community are virtually unsaleable for the moment, since there are so many financial unknowns. Now, they're about to hit a conversion date, and it's not going to be pretty for them.
They pretty much maxed out their purchasing power to buy that house...and it was the cheapest house on the market at the time. I warned them that they were flirting with danger, but they're about 30 and think nothing can go wrong in their life.
I had another offer on the house, too, so I tried to convince them not to do it, but they wanted a house in that town and they wanted it then, so I went ahead with the sale.
I hope they come out OK on it.
It's also going to be interesting to watch them begging for a new refi, when the bank doors are slammed in their faces. So many folks just assume that easy refis at low rates are some kind of naturally occurring phenomenon!
No assumptions, I read my contract with the mortgage co.
On the ARM--worst case scenario--I have to keep it. Given that the ARM had a low initial rate my principal has been reduced more than it would have under a conventional loan.
So each year I run interest rate risk, after the initial lock. As I did not stretch to buy the house, this is not a huge worry.
Realistic scenario--I move or refi within 5 years.
What, besides loss of job or major credit problems would prevent him from refinancing?
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