Watching out for those Option Arms

There are obvious signs that things will get worse before they get better. The option arms or pick-a-payment loans have to work themselves through. There is a huge group of homeowners who can not afford regular arms, can not afford to pay any principal and are already underwater. So know the truth and some will find out the hard way.

The upcoming wave of option arm recasts will be huge. Just looking at the upcoming tidal wave of option arms that are due to recast in the graph below. The comparison in numbers to the subprime levels are significant. The economy is already in tatters and this wave is still to come.

The second graph illustrates the recasts will come even sooner than expected due to the negative amortization feature of the loans. The negative feature is based on the value of the house when purchased not the current values - so it is easy to assess that these negatives are actually skewed upward. If real property valuations were used the number of negative house values or properties underwater would be substantially higher.

The fact remains that between 70-80% of the option arm customers can only pay the minimum payment. Therefore the negative recasts will hit well before the scheduled recasts. When this occurs the lenders and the homeowners will be in a world of hurt (most in both categories already are whether they admit it or not). Mr. Mortgage provides a list of the top option arm lenders -

• American Home Loans
• Bank United
• Countrywide
• Downey Savings
• First Federal
• IndyMac
• Wachovia
• Wamu

These recasts will not happen within a vacuum - there will be strong reverberations throughout the world. This will be stronger than the subprime breakdown - since the system is already very weak.

As Mish aptly uses a hurricane analogy. The option arms are the back of the hurricane - when the most damage is done. The front of the hurricane weakens the structures but the back demolishes and devastates things. Mish is right - now is the time to batten down the hatches.