Friday, April 17, 2009

Option ARM Foreclosures Delayed

The upcoming issues with the Option Arms look like problems will be delayed due to low interest rates (see here and here). Remember that the recasts are set at 110% to 125% of the principal on the loan. So properties purchased at market peak will have a huge gap between the new loan recast value and the present market value. Also, many of the owners are only paying the interest - either the teaser rate or interest only which is stemming off the recast but not lowering the principal.

The fact that these recasts have been pushed back does not mean that the foreclosures will not take place. It just means that for many homedebtors (only appropriate word for the context) the foreclosures will just be delayed. In the big picture it is probably hoped that the foreclosures will be delayed long enough for the markets to stabilize. However that does not mean that there will still be big losses coming for the lenders between the 125% recast rate and the current value.

BusinessWeek has an interesting article titled Good News: Option ARMs resets delayed. Let's take a look -

Option ARMs typically reset after five years, at which point the monthly bill increases 65% or more. About 37.5% of option ARMs originated in 2005 are still outstanding, 63% of the 2006 vintage are outstanding, and 82% of the 2007 loans remain, according to Barclays Capital (BCS). And about a third of the outstanding loans in these years are deeply delinquent.


The Mortgage Bankers Assn. is also estimating that the lower interest rates will delay the resets. But the group also expects that lenders will help borrowers move out of the option ARM products before they reset. Many of the investors who can't easily qualify for modifications and the borrowers beyond help have already lost their homes, says Michael Fratantoni, vice-president of single family research and policy development for the Mortgage Bankers Assn.

And the homeowners who are holding option ARMs when the wave of resets hits won't face as big a shock because interest rates have fallen, adds Fratantoni. "Interest rates have come down to the point where the resets that are going to occur are going to be a bit of a non-event," he says. "Very few borrowers will experience the recast." But Nicholas Chavarela, managing attorney for Orange (Calif.)-based America's Law Group, which represents borrowers negotiating modifications, says banks remain reluctant to reduce principal for underwater borrowers.


Under the plan, taxpayers and participating lenders would share the cost of cutting borrowers' debt-to-income ratio to 31%. Loans terms could be extended to 40 years and interest rates dropped to as low as 2%. But option ARM borrowers would likely have to pay more each month, even with a modification, because they'd suddenly be required to pay both interest and principal. "The Obama plan needs to be built upon," Chavarela said.

But even if they can refinance many borrowers can't afford the higher payments. Philip Tirone, president of the Mortgage Equity Group in Los Angeles, said he reached out to borrowers with option ARMs, offering to help them refinance into a fixed-rate mortgage with a low interest rate. "For them, it's all about the payments," Tirone said.


Keith Gumbinger, vice-president of, a publisher of loan information in Pompton Plains, N.J., said the lower interest rates have helped to diminish the option ARM problem. But it remains unclear how many option ARMs are left to reset and how many borrowers will be able to get out of the loans before it's too late. Moreover, by the time they do reset it is unclear whether the economy will be better off. If home values and unemployment continue to weaken, it will become even harder to refinance. But the delay in resets gives some motivated borrowers time to work with lenders and negotiate a solution.

It is all about payments that they can barely afford on a loan they can not. If the homedebtors can not afford more than the teaser rate how are they going to afford interest with principal. And since lenders are not willing to take such huge losses - what will happen to what these properties that are have principals that are up to 25% more than their peak prices? If there ever was a group that was perfect candidates for walking away, these are them. They own nothing. They can not afford their property. And they are too deep in debt to probably ever make it worth while.

And here is a graph depicting the recasts, notice how it tapers off 5 years after the housing industry imploded in 2007 -

Here is an example we gave of the problem last year to understand the numbers -

For example a Merced, CA house that was purchased at $400,000 may have a mortgage that has grown to $500,000 with a real current market value of $200,000, add in the $50,000 for foreclosure costs and the lender loses $350,000. The owner could not afford the payments on a $400,000 property when the economy was strong and gas was affordable.

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