Friday, July 4, 2008 at 11:23AM
Neg-Ams Already Going Delinquent
Hat tip to yourkillingmelarry for pointing out this article in BusinessWeek:
The next wave of foreclosures is expected to gather strength when the million or so option ARMs start resetting in large numbers next spring. But it seems that many of these loans, which allow borrowers to make minimum payments that don’t even cover the accrued interest, are already going delinquent.
According to a recent analysis by Lehman Brothers, option ARMs that originated in 2006 performed about as well as fixed-rate Alt-A debt for the first 12 months. But by the time they were 2 years old, about 2.1% of performing loans were going 60-days delinquent each month. Compare that to a 1.2% of current loans going delinquent with other Alt-A loans. The rate of increase in delinquencies is even beginning to approach that of subprime, which is about 2.5%.
“It’s a better quality borrower but the rate of increase in delinquency is looking closer to subprime than Alt-A,” said Akhil Mago, the head mortgage credit strategist for Lehman Brothers, said.
Strange, right? The loans were generally given to folks with good credit, most of whom are still only making minimum payments.
Looks like these borrowers might simply be giving up on the mortgages because they have less and less of an incentive to keep paying. Option ARMs give borrowers a choice of making a minimum payment that only covers a small portion of the interest, the rest of which is added to the loan balance. With years of unpaid interest accumulating and house prices falling, some homeowners have seen their equity disappear and now owe more than their initial loan balance. The gap between the original loan balance and the value of their home is only widening as home prices fall. Many of these borrowers were given the loans with only a requirement that they “state” their income rather than verify it (The result: Lots of folks exaggerated their salaries). So, these borrowers might only be able to afford the minimum payment, which can increase by 7.5% a year and then more than double when the loan recasts.
A major concern is that 70% of option arms are concentrated in California and Florida – two states that have already been hard hit by the housing slump. Subprime mortgages, on the other hand, were dispersed across the country (about 60% of them were outside Florida and California) And as prices in those states continue to fall, refinancing options for these borrowers disappear even as recasts loom.
Option ARMs originated in 2006 make up about $140 billion of the $350 billion of outstanding option ARMs and 45% to 50% of them are expected to default. The 2007 option ARMs, which were originated just as home prices began falling, are expected to perform similarly badly.
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Jim the Realtor
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Reader Comments (14)
It isn't possible for only 50% to default. There is an event horizon where they all implode and that is a lot less than 50%.
Hi Jim,
I'm really glad I found your blog. We live in San Jose now and are considering making a move to San Diego in the next year or so. I'm hoping to get a foreclosure property at 40-60% off its original price somewhere in the 2009-2010 timeframe. Should we decide to move to San Diego, I will definitely be in touch! You're one of the only real estate agents I know who is open and honest about this whole thing.
By the way, I wanted to buy a house in 2003 but couldn't justify paying 25% more than my rent payment. I have been renting in the same location since 2004. I'll be ready to buy once prices hit 2000-2001 levels. I am looking for a place in La Jolla or similar coastside area that was maybe originally $1.3M or so and now is $675K or so. I expect that will happen in the next couple of years. In the meantime, I have subscribed to your blog.
-Erica
It seems that at this point pretty much all bets are off. If people are walking by choice (Jim's last post), it doesn't even matter anymore what kind of loan they had. I already see 2007 knife catchers default on their loans (short sale right around the corner from us, was purchased in Feb of 2007). I guess what it will all come down to is that the mess will continue until house prices truly match what people can afford.
Fasten your seat belts, we are about to continue our descent.
Agreed - loan-type doesn't matter, just how the homeowner feels about being underwater. I doubt if many, if any of these 2006 neg-ams have reset.
It should mean we'll be picking up speed too, if the banks can keep pushing the foreclosures through.
Welcome Erica!
rob agreed...the event horizon will destroy san diego's economy. The week biotechs here are falling apart. The large pharmas are pulling out. This economy will depend entirely on california's legislature. I see no way that big conglomerates staying here when transferring peoples to other locations is non concern.
The angst at my work is off the hook. Most of the asian scientist bought in the last two years in those cookie-cutters in CV. The average wage inflation at our company was 2% this year, with promotion raises at 4%. We are the only part of Novartis that received a 3% increase in budget, they closed down the chiron vaccine facility in emeryville and decreased all other institutes budgets by 10%, yet novartis had the highest sales profit in history last year....
"People with good credit". . .the problem with that statement for bankers is similar to fund managers saying, "past performance is no indication of future performance." Credit history is just that - history.
No one can accurately predict the behaivor of millions of people when the age of easy credit ends. Based on some current trends, however, it isn't a pretty picture. The blame-game "Countrywide made me do this" seems to be the response, pushing blame to banks, etc. When this mind-set becomes mainstream, it isn't hard to predict millions more walking away from ARMS, etc.
Erica, even I think that much of a drop in La Jolla is a long-shot, but I like the way you think! By the time this whole thing shakes out, who knows?
Nate and Mark, to your points, I gotta believe things will fall, and fall hard out here in Cookie-Cutter Valley. This is mob-mentality at its finest!
@The Blur: Totally agreed. The good news is that if conforming loan limits settle below the $729,750 they're currently at, we may see some real price erosion in the $900,000 range. This is interesting to me since the $900K range is a range I can afford to buy in (and if I wait 2 years, with 20% down.) Not saying I necessarily WANT to spend that much...but if I find a good deal in that range, I'm OK with it. I don't necessarily want a sprawling mansion -- there are just the 2 of us, and we don't plan on having a lot of kids. So we'll see what happens! For now, I'm happy to wait. And rent. And watch this blog to see what's up. :)
The other problem with credit ratings, as a predictor of future credit worthiness, is that the algorithms are trained on data which doesn't consider underlying economic conditions. Most people don't realize that Fair Issacs uses neural network type algorithms to develop their credit scoring models, which are trained on sets of data to predict similar outcomes given similar inputs. This works well when the underlying economic conditions are constant, but breaks down when the underlying conditions change.
Most of their credit training and data has been from post 1970's (when credit driven consumerism really took off), and all of it is post 1930's (the last time we had a significant credit and economic correction). That means the models are at best off by a factor across the board, and at worst completely useless (probably closer to the former, though). Lenders are starting to realize this, as people with "good" credit scores will readily do "bad" credit things in a down market, if they feel it's in their best interests long-term.
On-topic side note:
I'd be surprised if only 50% of the neg-am option ARM's default. I'd guess very few people thinking of staying in a house more than a few years got a neg-am loan, and the market's not coming back any time soon. I don't have any info on the specifics or anything, but my uneducated guess would be 90% of neg-am option ARM's default, if not higher, unless there's a serious bailout. Just my opinion.
I think loan type does matter and does factor in the decision to ruthlessly default. In the ARM universe, loan type dictates when and how payments will change, and I cannot believe that monthly payments are not a significant consideration. I suspect there are many upside-down folks in So Cal with ARMS who were spared a substantial spike in payments due to the near halving of the USD LIBOR from last year's levels. I believe we would be seeing an even higher default rate if their payments would have increased significantly.
Nick,
You are on target! Very few neg-am borrowers/owners ever figured on living in their house. I'll bet that most checked the box to be owner/occupiers when in truth they leased the house to someone else and hoped to "cash in" with a higher resale after a year or two. Their folly will push prices for everyone else down as they traverse NOD to REO foreclosure sale.
Once the fools have been liquidated, we should see a solid up-tick in prices. Basically a market clearing process. But, the damn banks chew up so many months in their process of clearing the market. Meanwhile we all suffer.
"I'd guess very few people thinking of staying in a house more than a few years got a neg-am loan"
There is probably a very, very small contingent of borrowers who bought homes on adjustable, neg-am or other "creative financing" loans who would otherwise have paid cash for their homes and not worried much about resale value but took out the loans because for the brief period of their super-low rates they could put their funds into CDs and collect more in ordinary bank interest even after taxes. These people either already have or will use their cash to retire the debts as they originally planned to do when the loans reset. Everyone else who financed with these loans because it was the only way they could qualify for financing at all is probably toast.
I had to laugh when they compared how Option ARMS "performed" compared to Alt-As. When you make the minimum payment on an ARM, you are borrowing more money, not performing!
These loans are providing me a lot of comic relief these days.
This was in this morning's NY Times:
"WASHINGTON — With no end in sight to the turbulence in the housing and financial markets, the chairman of the Federal Reserve said on Tuesday morning that it would issue new lending rules next week to restrict exotic mortgages and high-cost loans for people with weak credit."
Talk about locking the barn door after the horses have escaped. Are there really any banks that are still writing loans like that to people with "weak credit," or for that matter, to anyone at all...?