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The rate of option ARM delinquencies is already spiking


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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