Business Week had this article in April entitled “Good News: Option ARMs Resets Delayed”, which included the latest Credit Suisse chart on recasting neg-ams:











Dr. Housing Bubble added the extra text and graphics to help explain the chart (above), and included it on his post today.  His point is that not only are there many homeowners sitting on neg-ams about to recast, but many specuvestors used them to purchase flips that are now unable to sell:


Let examine what happens when an option-arm recasts – DO TODAY’S LOWER RATES HELP?

Here’s an example using the terms that CHL used for non-owner occupied option-arm loans:

$500,000 loan

1.375% start rate (teaser rate)

9.95% life cap

115% of original loan = maximum limit of loan balance

3.025% margin over MTA (which in July, 2005 was 2.737 + 3.025 = 5.762%)

Recast every five years, or at 115%

An option-arm/neg-am borrower has the choice of paying the minimum payment, based on the teaser rate, or the “fully-indexed” rate, which is the index + margin:

1.375% payment = $1,689.84

5.762% payment = $2,921.68

Difference = $1,231.84

If the borrower only makes the minimum payment, the $1,231.84 is added to the loan balance.

I plotted the monthly payments in our example using the actual monthly MTA rates, and added the index to compute where the loan balance would be today.  Coincidentially, the rising loan balance would be hitting the 115% mark, or $575,000, right about now – if the borrower only made the minimum payment.

What would today’s new payment be after recast?    $2,823.61

May’s minimum payment?   $2,106.65

The increase in monthly payment after recasting would be $716.96 per month. 

Even with lower rates, that’s a hefty increase for a rental property, especially one with a long-term lease, – the difference will be coming out of the borrower’s pocket.

Owner-occupants might cough up the difference, in order to save the home they live in, but will tenants ante up more rent when their lease expires?  Not likely, and the landlords aren’t going to enjoy the pain long-term, unless they are really committed to saving their credit score.

The $716.96 is the difference at recast on a beginning loan balance of $500,000, you can extrapolate to determine what this means for those at higher price points.

If lenders would waive the recasts, this problem could be averted.  But I haven’t heard of any.


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