Ok, I’m going to add a couple posts today to get this forum up and hopping again…
First up: risky loans.
According to the ABC story on Calculated Risk’s blog today, 61% of purchase loans in California last year were interest only loans.
Did you get that?
61% of buyers in CA last year got a loan where they are only paying interest.
Do you think that is the riskiest loan out there? Not even!
Interest only loans are not as risky as partial-interest-only loans, otherwise known as Option ARMs. You have the option of paying only part of your interest AND it is adjustable.
An option ARM allows you to defer part of your interest payment; the unpaid part is added to your principal. While you get to write off the negative amortization on your tax return (I think), and the lender gets to claim it as income, what are the chances this unpaid interest will ever be paid? Worst of all, when the option ARM resets, it is like a neutron bomb.
Dugan: “The fundamental problem with payment option ARMs, other than the growing principal balance due to negative amortization, is payment shock. A traditional 30-year fixed-rate mortgage requires the borrower to amortize the principal balance through equal payments over the 30-year life of the loan.
In contrast, a typical payment-option ARM is a 30-year mortgage that permits five years of negative amortization by allowing a borrower to make very low minimum monthly payments during that period. Beginning in the sixth year, the borrower must begin paying the full amount of interest accruing each month, and must also begin amortizing the increased principal over the remaining 25-year life of the loan. The combination of these factors can produce sharply increased payments in year six.
For example, a typical payment-option mortgage of $360,000 at 6 percent can produce a monthly payment increase of nearly 50 percent in that year, assuming no change in interest rates. If rates rise to just 8 percent, the payment increase when amortization begins would nearly double.
….Is this an appropriate product to mass market to customers who may be looking at the less than fully amortizing minimum payment as the only way to afford a larger mortgage – at least for the five years before the onset of payment shock? And are lenders really prepared to deal with the consequences – including litigation risk – of providing such products in markets where real estate prices soften or decline, or where interest rates substantially increase? …. I fear the answer to all these questions may be “no.” – John Dugan, 12/1/05
Can you imagine what will happen to our economy when tens of millions of Americans are facing foreclosure due to neutron mortgages?
This is the time for lawyers to prepare for the biggest class action lawsuit since asbestos and DDT.
“…interest-only loans accounted for about 31 percent of all new mortgages last year, but David Lareah, chief economist with the National Association of Realtors, says he is more worried about option ARMs than interest-only loans.
“They are a lot more dangerous,” he says, because “the borrower is giving away part of his equity,” sometimes unknowingly. – David Lereah, June 2005
option ARMs are 1/4 of all loans in Wyoming (from the 9/1/06 Business Week cover story)
“And while they made up at least 40 percent of mortgages in Salinas, Calif., and 26 percent in Naples, Fla., they’re not just found in overheated coastal markets: Through Mar. 31 of this year, at least 51 percent of mortgages in West Virginia and 26% in Wyoming were option ARMs.
Stock and bond analysts estimate that as many as 1.3 million borrowers took out as much as $389 billion in option ARMs in 2004 and 2005. And it’s not letting up. Despite the housing slump, option ARMs totaling $77.2 billion were written in the second quarter of this year, according to investment bank Keefe, Bruyette & Woods Inc.”
UNQUOTE
So we’ve got about $1 trillion in option ARMs nationwide. Assuming a median US home price, slightly adjusted up for the higher prices in CA where they are more prevalent, let’s assume the average loan amount is $400K.
That is 2.5 mil homeowners in the US with option ARMs.
Does anyone care to take over from here? What is the impact of 2.5 mil homeowners faced with a mortgage increasing 50% to 100%, at a time the economy is slowing, they are possibly upside down on their mortgage or lost a job?
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