Below is great article I read that talks about “The Second Wave of Mortgage Defaults.” It is great story, one I have been telling my credit workshop students and home buyer workshop students. What it doesn’t mention the 3rd wave of defaults from Job Loss! We have not seen anything yet!
The Second Wave of Mortgage Defaults
By Jim Nelson
Our economy is about to relapse into the disease that sent us into the Great Depression: Part Deux. Subprime loans caused the initial illness. Option-ARMs will cause the relapse.
In the first half of the past decade, subprime loans were king. They were cheap and easy to get approved. Along with the subprime boom came subprime adjustable-rate mortgages (ARMs), which were equally easy to afford…for a while.
Of course, the “A” and the “R” in ARM meant that the interest rate borrowers pay changes, or resets. The majority of these resets occurred between the summer of 2007 and the summer of 2008.
This period saw a massive amount of mortgage interest rate hikes, which caused millions of foreclosures. Things spiraled down from there, eventually freezing nearly all credit and causing the panic of 2008.
Of course, that’s the 50-cent version of recent history. There were plenty of other financial calamities that went along with this, including the bundling of mortgage-backed securities and risky derivative products.
If you believe the Obama White House and the glass-half-full press corps, you’d think this mess is now behind us. We are, after all, in a recovery…right?
Unfortunately, no one is talking about the second wave of ARM resets and foreclosures…
You see, this second wave will come crashing even harder than the first. It’s made up of a type of mortgage called “Option ARMs.” These give borrowers the option of how much they want to pay during the first five or 10 years of repayment:
1) The full amortized rate, including interest and principal.
2) Interest only, or…
3) A token payment, well below the amount needed to cover the interest on the loan.
This third option causes the mortgage balance to INCREASE instead of decrease. And usually, the borrower can continue to make minimum payments until the mortgage balance increases to 125% of the original amount. That’s when the trouble begins…especially if the interest rate increases at the same time.
This is the exact situation in which many homeowners now find themselves.
Obviously, these option ARMs were supposed to be reserved for customers with better credit than those who took out subprime mortgages. But apparently, they were handed out to almost anyone who wanted them.
According to Whitney Tilson and Glenn Tongue of T2 Partners, who are experts on this subject, about 80% of option ARMs are negatively amortizing. Meaning these so-called top-tier borrowers are heading further into the hole. Once their rates reset, they could be in serious trouble.
And that could be happening very soon:
The chart above shows the two peaks in the mortgage-reset wave. The first peak is comprised of subprime ARM resets. And the second is mostly constructed of option ARM resets. We appear to be in the eye of the storm.
That fact alone shook our nerves when we first discovered it. But it was a different chart in Tilson and Tongue’s most recent presentation that really got us startled… It’s also the reason I’m predicting the dollar spike in 2010.
Instead of resetting as expected after the first five years, many option ARMs are so negatively amortized that they are hitting their automatic reset cap.
That means they are resetting early…like right now.
As you can see from the second chart, the expected reset peak was to occur in 2011. But the real peak is happening now. You can also see that the amount of mortgages resetting is spread over a longer period of time than originally thought, but is peaking much earlier. Unfortunately, it’s not the peaks that matter.
You see, those are just resets. But with unemployment reaching quarter- century highs every month, and the massive number of homeowners about to receive mortgage bills for two to three times what they are used to paying, we find ourselves in an even scarier environment than this time last year.
It takes anywhere between 3-12 months for most homeowners to actually go into foreclosure. Therefore, the wave of Option-ARMs that are now resetting could cause a major wave of foreclosures over the next 6 to 18 months.
It’s tough to say exactly when the storm will come. But my guess is the second half of 2010.
This second wave of foreclosures will not be good news for the economy or the stock market…At least that’s my guess.
for The Daily Reckoning
By Brian Faler and Dawn Kopecki
Oct. 29 (Bloomberg) — The Obama administration endorsed plans to extend an $8,000 tax credit for first-time homebuyers, saying it is helping stabilize the nation’s housing market.
The tax break, enacted earlier this year as part of an economic stimulus package, has “brought new families into the housing market and contributed to three consecutive months of rising home prices,” Treasury Secretary Timothy Geithner said today in a statement. The tax break will expire Nov. 30 unless Congress intervenes.
Senate Democrats have announced plans to extend the credit until April 30 while expanding it to include higher-income Americans and some who already own homes.
Senate Finance Committee Chairman Max Baucus said today the new plan would offer a $6,500 credit for homebuyers who have lived in their prior residence for at least five years. Couples earning up to $225,000 and individuals up to $125,000 would qualify for the break, Baucus said. That’s up from the current $75,000 limit for individuals and $150,000 for couples.
“The success of the American economy is closely tied to the success of the housing market – by helping to stabilize the housing market, the homebuyer tax credit has helped to shore up the economy as it begins to recover,” said Baucus. “This would enable an even greater number of potential homebuyers to take the credit.” Millions of renters earn more than $75,000, he said.
Democrats have been pushing to include the provisions in an unemployment benefits bill, which has been held up by a disagreement with Republicans over other proposed amendments.
Worst Price Drop
Lawmakers said they want to prevent home sales from slipping as the economy struggles to recover from the worst drop in home prices since the Great Depression. More than 1.2 million borrowers have claimed $8.5 billion of the $13.6 billion set aside for the homebuyer tax credits this year, according to the Treasury Department.
The Democrats’ proposal would extend the credit to home purchases under contract by April 30 so long as they close the sale within 60 days. Those buying homes worth more than $800,000 wouldn’t be eligible for the credit, said Baucus.
“We need to target the credit toward those potential home buyers who need it most, and not those home buyers who would have bought the new home without the new credit,” said Baucus.
Any legislation would have to be reconciled with a House unemployment measure approved last month that omits the homebuyer tax provisions and extends jobless benefits only in states with the highest unemployment rates. House Speaker Nancy Pelosi, a California Democrat, is waiting to see the final Senate agreement before deciding whether to support it, said spokesman Nadeam Elshami.
While the tax credit speeds demand for homes from next year to this year, it won’t necessarily increase overall sales, said Scott Buchta, head of investment strategy at Guggenheim Securities LLC in Chicago.
“They do need to expand the credit to get more people involved, but at the end of the day you are paying people tax dollars to do what they probably would have done anyway,” Buchta said. “If it is passed, home sales of lower-priced homes should continue to hold their ground. However, if it is not passed we will probably see home sales slow down as we wait for natural demand to build up again.”
Senate Majority Leader Harry Reid, a Nevada Democrat, said yesterday that there is significant support among both parties for the homebuyers’ tax credit. He said the other amendments sought by Republicans are unrelated to the unemployment bill and are designed to embarrass his colleagues. Republicans want to vote on amendments on immigration and to bar funding for the community activist group Acorn.
Senate Minority Leader Mitch McConnell, a Kentucky Republican, agreed that most lawmakers support the unemployment and homebuyer measures. “We’re not that far away from an agreement,” he said yesterday.
The $2.4 billion unemployment measure would extend jobless benefits by 14 weeks in all states and provide an additional six weeks of benefits in states with the highest unemployment rates. About 1.9 million Americans will exhaust their unemployment benefits by the end of this year unless Congress acts, the Labor Department said.