The Reset Storm - An Affordability Problem
A: While most are aware of the coming adjustable rate mortgage resets in 2008, I feel like the anticipated severity of the problem is being under-estimated. After all, a couple of hundred dollars a month extra may not be a big deal for you, but for many others it's enough to make living at that home unaffordable. At a time when new home sales are at a 12 year low, inventories and months supply at highs, we are about to enter a period of time when many struggling homeowners will be hit with payment shock. I want to share with you the copy of an 'ARM Reset Reminder Letter' that one such homeowner received; in essence warning the lendee of the coming payment increase.
This is going to happen to many people in 2008! This letter is from a small lender in Texas, while the homeowner is in New York. For privacy purposes, the letter was cropped to only show the message body, and all names/numbers were blacked out. I personally know the person who sent me this so I assure you it is real.
You should note that this homeowner's payment will rise $550, or about 12.5% of the total payment, and will continue to adjust further every 6 months for the life of the loan. The letter also had a clear statement advising the customer to call them to discuss the financial situation & options in more depth, if there will be problems meeting this debt obligation. Every struggling homeowner who either already hit their reset or received a similar warning letter should call their lender and be proactive about working out a deal!
From a macro perspective, this is not good. Thats a significant jump in monthly payments! And as you can see by the chart on the right (courtesy of Calculated Risk), 2008-2010 will bring a wave of resets for those that took out teaser/adjustable loan products. Forget the homeowners who already can't meet their debt obligations, it may be time to worry about those who feel they are OK now, but won't be in another 8-12 months! That payment increase will add up very quickly for those not paying attention to their mortgage situation, and I worry that a very bad financial situation will sneak up out of no where at a time when housing is already so down & out. This is an outright affordability problem both for homeowners & prospective buyers alike; a rare combination.
As far as Bush's rate freeze plan, recall that it doesn't apply to ALL struggling homeowners about to be hit with higher resets. And you recall my many rants about how this is NOT just a subprime problem (read "Not A Subprime Problem; Loan-To-Value Ratios"), but an overall mortgage/debt problem with many tentacles yet to reveal itself (option arms, hybrid arms, heloc's, credit cards, auto loans, etc.).
According to the Wall Street Journal's article "Option ARM's: Next Weakling":
The Bush administration is pushing its plan to help subprime borrowers whose loans are due to reset to higher interest rates next year. But left out of the mix are hundreds of thousands of borrowers with good credit who could face sharp increases in their payments.We are headed right into this storm, whether you like it or not. While the second half of 2007 saw many banks/brokerages/lenders/insurers visit the confessional and announce write-downs, 2008 will most likely see the consumers visiting the confessional as they no longer can meet their debt obligations and become delinquent. It has come time to move beyond fear & expectations, and into reality as what we were all scared of, finally arrives.These homeowners could be the next wave of trouble for the mortgage industry. They took out what are known as option adjustable-rate mortgages, or option ARMs, which give borrowers a choice about how much to pay back each month. If they choose to make only the minimum payment on a regular basis, their loan balance can actually rise.
In a report issued last week, Merrill Lynch economists called option ARMs "ticking time bombs" that will start "ticking louder next year." Merrill estimates that losses on option ARMs could total $100 billion, on top of an estimated $400 billion in losses on subprime and other mortgages.
UrbanDigs Says: Nothing I can do about wall street. Those holding bad assets will get slaughtered and either go bankrupt or be bought out. But I do care about the consumer who may be able to help themselves. Do yourself a favor and get re-acquainted with the terms of your loan if its any type of adjustable rate or negative amortizing product (interest-only arm, option arm, hybrid arm, cosi loan, cofi, loan, etc). Reach out to your lender if you foresee any problems meeting your housing payments after a reset. The last thing you want is to become a distressed seller when you least expect it, at a time that is very difficult for sellers in many local markets. I expect both housing & wall street to go through the worst of this storm in 2008, so if we can absorb the shock a bit by being more educated about the root cause of the problem, we should!
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Comments (5)
Could you provide any insight into usage of ARMs in Manhattan co-ops?
I have seen some co-ops accepting them but I don't know if this was extremely rare or was mostly accepted in the past 3 years.
Is this something to be concerned (or optimistic for vultures!) about?
Posted by uwsider | December 31, 2007 11:35 AM
uwsider - hmm, I'll try to look into for a future post. not sure.
however, I would think it wont affect us nearly as much as outside markets. its the side effects to wall st, lending, standards, rates, the us economy, etc.. that is to be of concern to us.
Posted by Noah | December 31, 2007 11:56 AM
Its hard to figure how exposed nyc re is to the option arm loans that were really popular in 2005-2007. Certainly the coop market is more insulated as their income restrictions, higher down payment requirements etc improve the odds that the purchaser is actually able to afford the place.
That said, I recall reading that for the first time, coop and condo sales reached parity in nyc. If 50% of the market takes a hit to pricing because option arms are no longer available in the quantities they were previously, that has to affect the coop market as well.
The housing bears, my self included, have been pointing to option arms as the harbinger of doom since early 2006. I can't speak for us all, but I never was worried about "sub prime" lending- I figured these people were high risk so were paying high rates, and their high rates of default were accounted for. The fact that the crisis started in sub prime should be very telling- the mountain of leveraged derivatives built on top of RE debt is in serious jeopardy- its built on assumptions that we're quickly learning are invalid.
Posted by drtomaso | January 1, 2008 5:50 AM
Noah, great piece and a real public service to real estate owners. Being pro-active on this issue if you have an adjustable rate product will be key. I continue to read articles where stock market, real estate market and economic bulls imply that banks have written off the kitchen sink and that sub prime mortgage losses will be less than what the write-offs imply. This may absolutely be correct, but they are missing the forest for the trees....as you point out. Student loans and car loans are going bad as will some LBO loans. Credit cards have had some help from the bankruptcy law change in late 2005 that cleaned out a lot of impending bad debt - buit stay tuned. My guess is that regular mortgage loans, commercial real estate loans and others will see rising defaults not just because of the apparent pervasive poor underwriting standards that resulted from the economic boom, but also due to the second order effects of the slowing economy. I will have more on this in a post I am working on.
Posted by jeff | January 2, 2008 9:37 AM
thanks Jeff!! grim to look forward to but might as well try to bet the right way on wall street so we can profit if it happens.
Posted by Noah | January 11, 2008 9:20 PM