The rate of option ARM delinquencies is already spiking

Posted by: Prashant Gopal on July 02, 2008

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.


Reader Comments

Sean

July 5, 2008 05:05 AM

Yes, our esteemed senators are running out of time to pass that $300 billion FHA bailout bill to help "working families." The trick is to to allow banks to push their worst borrowers into FHA loans and to all the (get this, really) allow the BANKS to hire appraisers (wink, wink) to figure out what the "market price" is from which the lender has to shave off 15% for the new loan balance.

The senate knows that Americans are too desperately stupid to notice that the same banks that encouraged fraudulent appraisals to enable this toxic lending spree for profits of hundreds of billions of dollars is now going to be tasked with selecting which borrowers to push to FHA and also to appraise the houses themselves.

Such deceit.

Sean

July 5, 2008 05:08 AM

Yes, our esteemed senators are running out of time to pass that $300 billion FHA bailout bill to help "working families." The trick is to to allow banks to push their worst borrowers into FHA loans and to all the (get this, really) allow the BANKS to hire appraisers (wink, wink) to figure out what the "market price" is from which the lender has to shave off 15% for the new loan balance.

The senate knows that Americans are too desperately stupid to notice that the same banks that encouraged fraudulent appraisals to enable this toxic lending spree for profits of hundreds of billions of dollars is now going to be tasked with selecting which borrowers to push to FHA and also to appraise the houses themselves.

Such deceit.

Tom Lowe

July 5, 2008 07:19 AM

Oh come on: we all know that subprimers are to blame for everything from housing to high oil prices. I know that because the mainstream news told me so a couple million times.

David the Renter

July 5, 2008 01:02 PM

Let them all lose their homes.

larry s

July 5, 2008 06:55 PM

it has become a good "business" decision to stop paying your mortgage if the mortgage balance is more than the value of the home by any more than 20%. the banks will be forced to either reduce the mortgage balance or get the property back & have to deal with selling it for the same amount that they could just re-work with the current mortgagee. damned if you do damned if you dont, and the borrower will be best served to force the issue. strictly business.

jbunniii

July 6, 2008 11:51 AM

"The result: Lots of folks exaggerated their salaries)" - You might have at least mentioned in passing that this is felony fraud in most cases, and should be prosecuted as such. At minimum, no "bailout" or loan adjustment should be available to anyone who cannot demonstrate that they were truthful on their applications.

SF Bay Area Buyer

July 8, 2008 06:46 PM

We are still way off our long term trend. Home prices will continue to decline until med prices reach med incomes. Any prudent loan officer will only lend to the clients who have verifiable income and the home prices ( Loan) will be carried at 3-4x income.

There is a bottom and I can point to it. I wont buy until prices reach the bottom.

http://www.housingbubblebust.com/OFHEO/Major/NorCal.html

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About

BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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