Friday, September 5, 2008

Option Arm Trouble Ahead - Proceed with Caution

The trouble surrounding Option ARMs or pick-a-payments are coming. Unlike regular ARMs where holding down the interest rates to very low levels can post-pone the troubles that luxury is not available to Option ARMs. With huge numbers not even able to make a full ARM payment and routinely having negative amortizing loans things will get very ugly. And no quick fixes are really available to resolve the upcoming issues. This article from CNBC titled ARM Resets: Tsunami Ahead gives the same warning that we have here and here. Lets take a look at the article -

Last year, everyone was worried that the resets on subprime loans would force borrowers into higher interest rates and payments. This element of the housing slide and credit crunch has subsided a bit. Akiva Dickstein, Managing Director of Fixed Income Research at Merrill Lynch explained, "Subprime and ARMs have become less of a problem recently because short rates have come down so much. If the Fed decides to raise rates the issue will return. However, even without reset difficulties, subprime and Alt-A loans are slipping into default at very high rates. The concern about future resets has given way to concern about borrowers equity erosion."

However, the Option ARMs and Interest Only (IOs) loans scheduled to reset in the next few years will add more trouble. These loans represent about 15% of securitized loans and some have negatively amortized, increasing the payments and making refinancing more difficult. According to data from Barclay's, about $300 billion in option ARMs and $820 billion in IO's are set to recast. The results could be payment shocks over 80% for option ARMs and over 60% for IOs according to Barclay's.

So when things are "moderating", it appears to only be for the time being. Does this mean that the home builders like Toll Brothers, Pulte Homes or Centex will fall more? Not according to Jim Cramer. Cramer projects a housing bottom by June, and recommended the Housing Index as a way to play the sector. Either way, over the coming quarters, pay attention to news from these builders as well as the Financials including banks like Citigroup and the GSE's, Freddie and Fannie.

While the positive spin at the end tries to down-play some of the forthcoming problems, the graph that is included in the article does nor present the same optimistic outlook.

Option ARM Recast and Payment Shock Forecast

This will be a huge problem that will be difficult to address. And the problems created with the recasts will reverberate throughout the country.

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