Option ARMS & Economic Recovery

If you were paying attention to the news over the last couple of years, you may have noticed a bit of a global financial hiccup that brought down house prices, stock markets and some banks while driving up unemployment.  Subprime mortgages where blamed, because apparently loaning people money they can’t pay back to buy houses that are priced on enthusiasm rather than fundamentals is not a good long term business strategy.

Fortunately as of late some soothsayers are seeing green shoots that indicate the recession is nearing an end.  This would mean that even if prices and economic activity don’t shoot back up to boom levels they would at least stop falling.

Unfortunately other soothsayers are seeing yet another problem on the horizon before this whole situation calms down: The bulk of Option ARMS are going to reset in 2011.  These are the ‘pick a payment‘ mortgages that are perfect for sophisticated buyers with growing incomes, but can quickly get out of hand if the buyer chooses the negative amortization route.  In the US about 40% of these loans made in 2006 – 2007 are already delinquent.

New Barclays Capital research from Sandeep Bordia and colleagues shows that the recasts in the next year or so are expected to be a minor event. But by mid-2011, these borrowers are forecast to see payments that are 50% to 80% higher than what they are grappling with now. (Many of these option ARMS are concentrated in former hot-spot real estate markets, such as California and Florida.)

Modification don’t seem to be working with these particularly noxious loans. In the face rising payments, borrowers don’t have an incentive to keep up with their current payments for homes that are already so horrendously under water, i.e. the loan amount is far above the current value of the property. Bordia says that many of the option ARM loans that do get modified turn delinquent soon after anyway. They’ve crunched some numbers and forecast that 95% of the loans that are slated for modification will eventually default. If you think that sounds bad, get this: They say that 80% of the option ARM loans out there that are ok and up-to-date as of right now will eventually default, too.

So are the coming resets in Option ARMS going to be another sub-prime crisis, or is this just a ‘sky is falling’ redux of the Y2K hype?  Either way I hope somebody is watering those green shoots.

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11 years ago

Todd is a great example of "not thinking" – or at least "not researching, and THEN thinking". As such he is simply rather typical for a Vancouverite. Bless, the simple creatures.

patriotzed
patriotzed
11 years ago

Todd:

I don’t think real estate is that high in bc on a global scale.

Vancouver has among the highest price/income and price/rent ratios in the entire world.

So what planet are you from?

I usually ignore this kind of post, but I couldn't resist the comeback.

🙂

Anonymous
Anonymous
11 years ago

Housing Market Teeters Between Recovery, Relapse
http://www.washingtonpost.com/wp-dyn/content/arti

Whoaa!
11 years ago

http://vancouvercondo.info/2009/07/option-arms-ec

Careful Todd, this is a bear blog, the cup is always half full, most of the posters live in those basement suites you mention. Either that or they hate vancouver and are looking to move to Flin Flon. Our posts will eventually shrink to the size of their minds .

Todd
Todd
11 years ago

Everyone here is so negative that they are never going to own property and will always rent and sub standard rental housing.

A lot people are fixing there interest rates at very low rates for 5 years or more. If inflation increases during this period even if mortgage rates go up they should be protected.

Is it cheaper to rent? Look at the listing, if you want a nice place in Kits your looking 1,400 for a basement suite, check out Craigslist.

I don't think real estate is that high in bc on a global scale.

NO -LYMPICS
NO -LYMPICS
11 years ago

Housing Recovery: Sell Now Or Your Capital Will Be Trapped http://www.oftwominds.com/blogjuly09/rates-capita… QUOTE: As interest rates rise, then the Capital Trap shuts on all equity locked in real estate. I covered this subject last year: The Housing Capital Trap Snaps Shut (May 28, 2008) The mechanism can best be illustrated with an example. Let's say a homeowner who bought long ago has a $100,000 mortgage on a home which was once worth $450,00 at the bubble peak. Now the property has sunk to a value of $250,000. The owner still has $150,000 in equity: quite a substantial sum. But if interest rates double, then the house would have to fall roughly in half to be affordable to buyers. Equity would shrink to a mere $25,000. Or alternatively, if the owner insisted the "true value" was still $250,000 based on other metrics,… Read more »

NO -LYMPICS
NO -LYMPICS
11 years ago

Short 1500 Volunteers ? Awww ……poor VANOC: Maybe their is a very good reason. I've been told by some informed parties that being a VANOC Volunteer takes a lot more time, commitment and personal cost than simply wearing a shit- eating grin for 2 weeks. Some potential volunteers have also stated that VANOC wants you to fit VANOC's schedule and a sport VANOC assigns you…thus turning off Volunteers. Some of the more amusing Volunteer positions I have been informed of involve the glory of accompanying athletes to the washroom and making 100% sure they pee in the bottles for the drug tests. I'll be wearing shit – eating grin if 2010 falls flat on its face….and I think the early warning signs are that it will. VANOC's latest plea simply adds to the list. PS Anyone got an update on… Read more »

patriotzed
patriotzed
11 years ago

NO -LYMPICS: However, a sign on one persons property says “CALL A LAWYER BEFORE YOU BUY AN RV PAD “. That anyone should even feel the need to point this out demonstrates the current sorry state of the BC mindset. You need a lawyer for any RE transaction. And moving on: Friends, Vancouverites, countrymen – lend us your employees: Lend us your employees, Olympic organizers plead Vancouver's Olympic Organizing Committee is calling on businesses and governments Thursday to lend some of their staff to fill their 1,500-volunteer shortfall. Many of the openings involve senior positions, from managing the Cultural Olympiad festival to co-ordinating broadcast operations. Well businesses may be a bit reluctant as they have the bottom line to look after but I'm sure the provincial government can lend a little off-the-books assistance, eh Gordo? "The Olympics can no more… Read more »

NO -LYMPICS
NO -LYMPICS
11 years ago

Been out of town for a week ……so some catching up on this VCI blog: Was up in the Shuswap area. Real Estate up in that area is "interesting". One latest trend is to buy a strata pad to park your RV or approved mobile home. One can buy a serviced pad of approx 2500 sq. ft . for $70,000. However, a sign on one persons property says "CALL A LAWYER BEFORE YOU BUY AN RV PAD ". Upon inquiry, I found out that one developer had left many RV pad owners hanging by not giving them title to their RV pads and had used the funds to purchase more land to do the same RV development nearby. They bought up another private campsite and began developing, but stopped and it has sat frozen for a year. These people are… Read more »

patriotzed
patriotzed
11 years ago

Any mortgage where the principal exceeds the fundamental value of the property (the net rental income discounted to present value using the prevailing interest rate over the amortization period) is economically unsound and prone to default. That's whether you have a US-style option-ARM or a Canadian-style floating rate or short term mortgage. Needless to say the principal has greatly exceeded fundamental value by any credible estimate for any property purchased in Vancouver over the last 4 years. Because the lender is (or will soon be) paying more in financing costs than the economic return on the property (net rental value) the portfolio (property/mortgage) is bleeding the owner's wealth with every payment. As will be the case for a vast number of Vancouver property "owners" for decades to come. No investor in his right mind would borrow money at 3.5% to… Read more »

Anonymous
Anonymous
11 years ago

bums up2: "…am expecting basically no price appreciation over the next decade"

Real appreciation is likely to be negative. Whether or not nominal prices decline is irrelevant if you can do better by investing elsewhere. Looking for avoiding nominal price declines is nothing but a way of saving face and justifying why your bad investment is actually, well, not so bad after all.

NO -LYMPICS
NO -LYMPICS
11 years ago

From Garth's blog… (Some crystal ball numbers) QUOTE: But, hey, free country. That’s their choice. If they think this is Japan, and rates will stay at 0% for a decade, no prob. Amoritize yourself silly. If they think house prices can rise by 5% a year for the next decade, putting the average Toronto home at $648,000, then believe that, too, However, crunch this: If the typical Toronto home does hit $648,000 (and realtors claim an annual 5% appreciation rate is ‘normal’), and if mortgage rates return to their 20-year average of 8%, then to buy it with 10% down ($65,000 in cash, plus another for $18,100 in land transfer tax, plus closing costs) will mean mortgage payments of $4,500. Add in a grand a month for property tax and monthlies, and that ends up being a cash flow drain… Read more »

NO -LYMPICS
NO -LYMPICS
11 years ago

RE: Option ARMS & Economic Recovery Its very simple isn't it? Stupidity and greed knows no economic,ethnic , cultural etc, bounds. The first wave of stoopidity was the subprime, with stories of people on welfare being given mortgages, or hairdressers buying 5 condos etc. etc. based on the myth real estate can never go down. This was simply a social engineering experiment with roots back into the Clinton Democrats which created a level playing field all right, one of quicksand for the middle class. This Option Arm seems to imply parties of more secure and higher incomes got sucked in as well with another circus act of cheap money financing. IMHO, even if the Option Arm never existed, the seeds were already sown, with far too much real estate already in default, dragging A-L-L prices down across the board. Now… Read more »

NO -LYMPICS
NO -LYMPICS
11 years ago

From $450,000 to $35,500: A 93% price drop in Palm Springs

http://www.redfin.com/CA/Palm-Springs/398-W-Palm-

Mark Downs
Mark Downs
11 years ago

By "no price appreciation" do you mean your expecting prices to drop year over year for more than a decade like they did in japan?

cashisking
cashisking
11 years ago

bums up2 Short term interest rates set by the gov't only have a bearing on variable rate mortgages – gov't rates are already at ZERO – I would suggest they only have one way to go. Long term rates are set by the market – right now they are pricing in a long drawn out recession (even with the 10% bounce in the last few months). They are also affected by the credit quality of the issuer and the demand for money – I would suggest that if you look at both these factors rates will 1) stay low b/c the economy sucks – bad for asset prices and 2) Have you seen the deficits being run by all levels of gov't domestic and foreign – bad for rates staying low. We are at the lows of a 25 year… Read more »

bums up2
bums up2
11 years ago

I agree, and am expecting basically no price appreciation over the next decade as well.

Anonymous
Anonymous
11 years ago

"Look to Japan’s experience of the past 20 years to know where interest rates are heading. This bear is about to capitulate."

I'd suggest looking at graphs of Japanese home prices since 1989 and report back on how low interest rates helped prop up prices. Not well at all, in the end.

bums up2
bums up2
11 years ago

I think interest rates will stay low and have no fear of variable rate financing.

Look to Japan's experience of the past 20 years to know where interest rates are heading. This bear is about to capitulate.

(Time will tell if that makes me the greatest fool or not!) 🙂

shalimar
shalimar
11 years ago

Attention should be paid to the difference with "reset" of interest rates which are artificially low and "recast" of payment where the payment has to cover interest and principal.

The result will be the same though.

Thanks Satv,John.
Thanks Satv,John.
11 years ago

An observer:Do you think ftb's can throw multiple offers? Try to understand the topic do not confuse yourself,There is no more legs to shoot down, current leg is the only option left for this world and there is no more downturn in decades to come in "the best place on earth".

VanBanker
VanBanker
11 years ago

"An observer Says:

July 30th, 2009 at 9:03 am

Could this not be applied to all the FTB that are currently snapping up RE in Vancouver simply due to all time low mortgage rates? What will happen when their mortgages “re-set”? There is little doubt that mortgage rates will be higher when it is time to renew. How high…who knows, but I don’t think it will be pretty for a lot of people."

Exactly. Although it won't be quite as bad as the US, some Option ARMs there go from 3% to 12% or other ridiculous resets.

An observer
An observer
11 years ago

Could this not be applied to all the FTB that are currently snapping up RE in Vancouver simply due to all time low mortgage rates? What will happen when their mortgages "re-set"? There is little doubt that mortgage rates will be higher when it is time to renew. How high…who knows, but I don't think it will be pretty for a lot of people.