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.