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When considering buying a house, wouldn’t it be nice to know how many people around you have a neg-am loan?  This isn’t readily-available information, unfortunately.  But if you are thinking about buying in a new or newer tract, you can judge by the builder’s in-house lender. 

The builders give incentives to buyers to use the in-house guy, and it’s usually enough money that it’s crazy to NOT use them, as long as the rates and programs are competitive.

Take Pardee Home Loans, for example.  They are a joint-venture with Wells Fargo, and though Wells has had their share of write-offs lately, they weren’t from neg-am loans – they’ve never done one.

So those of you who might consider buying in a Pardee tract around Carmel Valley, and are waiting for the resetting neg-ams to kick in, you might be disappointed.  Work with a five-year and seven-year timetable instead, Wells Fargo is more of 5 and 7-year-fixed lender, for those borrowers who may have taken a loan other than a 30-year fixed. 

Hat tip to yourkillingmelarry for pointing out this article in BusinessWeek:

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.

Bold added

Yesterday Ben Jones of thehousingbubbleblog.com fame was in Carlsbad as part of his west coast swing to say hello and thanks to his readers.  http://thehousingbubbleblog.com/?p=4610

CA renter, Rich Toscano, Kelly Bennett, Schahrzad, barnaby33, and a number of other familiar folks were there enjoying the beer and company (see pics below).

As I was leaving, a guy who wasn’t part of the group grabs me and mentions that barnaby33 said we should talk.

He goes on to describe his real estate experience over the last two years.  Some realtor & lender encouraged him to start buying properties, so he bought three houses in Oceanside in 2006, all on neg-am mortgages.  Now, just two years later, his neg-ams are resetting.  The mortgage on the house he lives in had its payment increase from $1,900 to $3,800 per month after just two years!

In my previous example, using the actual payments over the last 35 months, it showed the reset happening between the fourth and fifth year – how did he hit his reset in just two years?

It’s because the loan originator got paid more commission from bringing in loans with a higher margin, causing the fully-indexed payment (and monthly deferred interest) to be much higher.

Countrywide, Washington Mutual, et al., were paying a bounty to mortgage brokers to originate loans that reset faster.  Think they have any regrets about that now?  They have another three properties coming back to them from this one buyer, and the disdain he had for the participants was obvious. 

The lingering effects of this mess will last a long time, far beyond the impact to this buyer’s credit report.  Think he’ll be trusting many realtors or mortgage brokers the rest of his life?  It would help if the NAR or Department of Real Estate came in with some hard-hitting sanctions or pulled licenses from those agents who took such advantage of people.   Instead, they have their hands in their pockets, looking around at everyone else, saying "who knew?"

Rich Toscano and Kelly Bennett

Schahrzad Berkland and Jim

Businessweek has a new article about neg-am loans that features an updated reset chart from Credit Suisse.  We were just talking about getting an update, and here it is:

Blue bars on the chart represent the recast schedule if all the loans were to recast five years after origination date. Gray bars represent the expected schedule of option ARM resets, which show loans recasting sooner after hitting the principal cap. By Credit Suisse

Based on the reports of 70% to 80% of the neg-am borrowers only paying the minimum payment, the resets will be coming faster (the gray bars), because their loan balances are rising – reaching their 115% reset cap sooner than the other reset possibility, ‘after five years’.  Washington Mutual and  Countrywide imposed the 115% reset cap which is much lower than the more-traditional 125% cap that Great Western, Home Savings, and World Savings used, and now it’s time they paid the piper.  If they would have left the resets at 125% or 10 years, like World Savings did, they wouldn’t be faced with nearly as big of a problem.

Let’s look at an example.

If you are only paying the minimum, and deferring the difference, once the new total balance grows to 15% over the original balance, then you lose the minimum payment option, and have to pay the full amount due each month. 

When you receive your initial truth-in-lending statement, the lender is only required to disclose what happens based on the first day’s interest rate only – there is no illustration of what happens if rates go higher.  But we can follow an example of a mortgage originated in July, 2005, and see how close they would be today to their reset point.  Here is a typical Countrywide mortgage, and how it has performed since July, 2005:

$500,000 loan amount, neg-am with a 115% reset cap or five years, whichever is first.

1% initial teaser rate, with a 2.625% margin over the MTA index.

Initial minimum payment = $1,608.20

Actual payment due, 2nd month = $2,835.81

Deferred interest after 35 months = $55,419.38

Maximum deferred interest before reset = $75,000

Amount left to defer = $19,580.62

Approximate time left before reset = 19 months

Minimum payment in 19 months = $2,141.26

Mo. payment after reset = $3,599.02

Mo. payment shock in 19 months = $1,457.76

The fully amortized payment is calculated based on the MTA index at 3.29 + the margin of 2.625% and amortized over the remaining 315 months.

The borrowers got into this deal when the payment was only $1,608.20, and that minimum payment goes up every year – getting them used to a higher payment.  If they’ve been able to handle an extra $120/month increase each year, then good for them.  But will they be able to handle it when it goes up $1,457.76 in one month?

There is an easy way for the lenders to fix this problem – just suspend the reset, and/or push it back to the 10th year.  World Savings (Wachovia) has been doing 10-year resets or 125% all along, so don’t believe the commentors when they say Wachovia is in the same boat as others – they’re not.  It was when Countrywide and Washington Mutual got greedy and pushed down the reset caps to 115% and five years that these loans became super-toxic.

But you can’t keep deferring interest forever, can you?  The technical difference in these loans is that the amount deferred gets smaller every year, and if you can catch rates dropping, the gap narrows quickly.

The difference between the minimum payment and the fully-amortized payment back in April, 2007 was $1,820.13.  By July of this year it will be down to around $1,000/month.  As that gap narrows, the reset date is pushed out further.

Back to the chart, and the 19 months.  If the neg-am in this example will be facing a reset in 19 months, that puts it in the beginning of the year 2010 – which looks like the peak of the gray-bars chart.  We remember that 2005 was the craziest part of the frenzy, so it looks like the gray-bar chart is the most accurate we’ve seen.  It also brings into question the blue-bar chart that shows 2011 is the peak.  It is based on five years after origination, and that would mean there were substantially more neg-am originated in 2006 than in 2005?  That’s hard to believe, but either way, we’re just getting started!

Hat tip to GLG for mentioning the Businessweek article about neg-ams:

http://www.businessweek.com/lifestyle/content/jun2008/bw2008065_526168.htm?campaign_id=yhoo