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:
http://www.businessweek.com/lifestyle/content/apr2009/bw20090416_103126.htm
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.
Dr. Housing Bubble has been 100% accurate when predicting the housing trend last few years. If anything, his predictions tended to be more optimistic than the actual result. Ignore him at your own peril.
If he is right, San Diego’s upper to middle market is not immune. Give it a couple of more years and you will see a signficant drop in the prices.
Yeah, yeah, whatever. We’ll see if Dr. Housing Bubble is right. With a name like that the news has to be bad.
By the way, how’s that tsunami of foreclosures going?
I can’t help but find it funny to hear a “yeah, yeah, whatever” response to the data in that chart. That’s pretty much the kind of analysis that led to the housing bubble in the first place. If someone has some reasoned arguments as to why those recasts would not be expected to have a big impact on mid to upper end San Diego housing, it would be interesting to hear it.
Yeah, yeah, whatever.
This is the land of pink ponies. All of our recasts will be reset by Obama. We all keep our jobs and money magically appears whenever we need it. No reason to save a dime. It’s like manna from heaven. We’re not dependent on a goldilocks economy because we’ve got a bunch of rich foreigners to bail us out.
And, the boomers want to move here. Every place sucks but San Diego. Especially those a-holes in places like Ventura and OC. What a bunch of douchebags.
Chuck Ponzi
Mozart – think you are kind of lost.
Bam is 100% accurate. the middle and upper end pricing will be drastically coming down -especially the high end – over the next two years. Average pricing will be near 2001 levels- there is absolutely no way around it.
Typically the highend is the last to fall in a market decline and when it falls – it tanks! It is also the first to recover.
What is recovering now? Low end entry level homes all because of the Cali “sheeple”(IQ under 80) mentality and nothing more.
As far as the Tsunami- Dont think there will be tsunami-It will be more of a steady increase that will last for years. As I am in the REO industry and speak to many different clients- this seems to be what is just right now starting to happen .
As the article states, most option ARMs go delinquent long before the recast, making both the graph and your calculation irrelevant. Sorry.
Also, mid-’10 recast rate corresponds to approximately 10,000 houses per month in the entire country, assuming average balance of $500,000 per loan. That’s a drop in the bucket. Normal existing home sales rate is 400,000 houses per month.
If someone has some reasoned arguments as to why those recasts would not be expected to have a big impact on mid to upper end San Diego housing, it would be interesting to hear it.
How about “because they are (were) concentrated in mid to lower end such as Eastlake”?
How about “because they are (were) concentrated in mid to lower end such as Eastlake”?
Nameless- Could you point out a tract or development of houses sold in Eastlake since 2004 that had an average sales price of less than 600K? I’m trying to see where these are going to pop up. My bet is that the option ARM problem in Eastlake would be for second owners.
I think it is really hard to figure what impact these recasts will have, but my gut sense is that it will be a trickle effect, not a flood.
I think we will see a lot of loan mods happen as recasts will qualify as a hardship and it will be a lot easier for a lender to justify putting these things into a making home affordable or indymac type streamlined plan, target the payment and rate to 31% or 38% or so of household income, take the servicing payments from the government, and capitilize the rest to the back end. This way they won’t have to restate their earnings they have already booked on all the unpaid neg am interest.
It might be a little tougher to mod these things on the investor side, but it should still work. The rental income on a real estate investment should be easy to document, and I would think that the net present value to the lender of lowering the payment and retention would outweigh the foreclosure option.
One thing I have not seen data on is how many of these pay-option arms were securitized? my sense is that they were done more by the Downeys, Wachovias, WaMUs, held on their own books to juice their short term earnings, and were not as securitized, but I don’t know. If anyone knows of any data on this, let us know.
By the time this is all said and done, the recast chart in this article could be stretched out for a decade or two.
“If someone has some reasoned arguments as to why those recasts would not be expected to have a big impact on mid to upper end San Diego housing, it would be interesting to hear it.”
I’m not sure I’d stand behind the argument, but I think I could at least come up with a scenario where they might avoid serious impact.
Over the next 5-10 years the government continues to provide the funds necessary to keep banks alive. The banks continue to trickle inventory onto the market vs. a flood as they are doing right this second.
Prices +/- 10% and or freeze during this time, while inflation chips away.
Interest rates rise, but a government program to offer low interest rates specifically for mortgages is put into place.
(Imagine if CV had 3 REO for sale each month, for the next 10 years, with low rate mortgages available.)
Could you point out a tract or development of houses sold in Eastlake since 2004 that had an average sales price of less than 600K
Summit should fit your profile (townhouses northeast of Olympic Parkway and Eastlake Parkway), those sold for 400-600K at the peak.
Option ARM foreclosures should pop up all over the place, though. In Rolling Hills Ranch (extreme northeast corner of Eastlake towards Mount Miguel), probably a third of all original loans from 2005-06 were option ARMs.
I think sometimes the impact of these things might be clouded by the fact that we cannot relate to the magnitude of these numbers.
Based on this chart it looks like the average amount of the loan resetting over the next 3 years is about $7B per month. This is a huge number, at least to most of us.
Just for grins lets compare it to the Subprime resets from 2007-2008. As far as I can tell the subprime loans that were resetting during 2007-2008 were at a rate of about $15-20 Billion per month.
Although the option ARM resets are over a longer period, it does not appear that the cumulative magnitude is as large as the subprime debt.
And it will be spread out over a longer time frame.
I tend to agree with vegas_nrba and expect a steady increase in foreclosures due to these resets, rather than a tsunami,
I’m with sdnerd and the King, this’ll painfully drag out for years.
I spoke with a REO guy yesterday who is inside the machine, and he said that he saw 300 new assets get released last week from one lender.
300, nationwide.
You could release every bank-owned property in Carmel Valley this week, and they’d all be in escrow by the end of the month.
Just for grins lets compare it to the Subprime resets from 2007-2008. As far as I can tell the subprime loans that were resetting during 2007-2008 were at a rate of about $15-20 Billion per month
Not only were subprime loans resetting at the rate that was 3 times higher in terms of dollar value, but the average subprime balance was roughly 2 times lower (~200k for subprime vs ~450k for option arms). Which means that the actual number of foreclosures hitting the market from the second wave should be 1/6’th of the first wave.
Jim,
Unfortunately I think you, sdnerd, and King are all correct as well.
Banks don’t have to sell now that we’ve given them all our tax dollars via tarp.
This sucks
Not only were subprime loans resetting at the rate that was 3 times higher in terms of dollar value, but the average subprime balance was roughly 2 times lower (~200k for subprime vs ~450k for option arms). Which means that the actual number of foreclosures hitting the market from the second wave should be 1/6?th of the first wave.
Hmmmm … good point. Definitely fewer properties, even if the dollar amounts are similar.
You say 1/6 the volume — that’s about 16%. For homes priced >700,000 you need at least 150,000 of household income. What is that, 2-5% of the population that would qualify?
In these terms, 1/6 of the volume looks downright scary.
Jim
I see you are back to promoting the the banks increase the recast or waive the recast hurdle. Lets hope as taxpayers this never ever happens. Wachovia did not get forced out of business because of losses, but rather because it could not continue to to come up with the money to pay its lenders when their borrowers were paying 1.375% on $120B. If it is waived it is an even larger bail out for taxpayers.
The other thing I find interesting is the person who asserts most of these loans have gone bad already. There is no data to support that statement. Why would an owner occupied (80% plus in Ca according to Dr Housing bubble) walk away prior to recast? The subsidized payment is much lower than any other equivalent rent. Which also means all the flippers would not walk away since they could still be cash flow positive until recast.
I believe (and the data supports) many/most of the loans are outstanding and it will be a disaster.
Kingside is right re the likelihood of lots and lots of mods in coming years. Unless of course the paper-holder refuses to authorize a mod because they have insurance for a default…and they threaten litigation for violation of the pooling & servicing agreement. But of course if the insurer is or is about to become insolvent, mods away I suppose. Oh what a tangled web…
As for reference to the higher-end properties, is there really a dispute as to what is happening and what is going to happen? Even with oodles of mods, how in the world can massive devaluation be avoided? Okay, not how can it, but will it? Of course not. Jim’s own examples of Carlsbad higher-end properties in the prior thread speak volumes to this fact. Go look at the earlier thread. Look at what has happened already with these homes – a $575K loss? a $477K loss? a $327K loss? We’re talking 30-40% declines and we are not done yet.
I think Jim may have loosely predicted another 10-20% downside before it’s over. Going with Jim’s call (if I have it right – if not, sorry buddy), on an $800Kish home that has already been slammed down from $1.2ish, we may see comps closing down in the mid 6’s before the pain train turns the bend. Yee-ouch! But I cannot disagree and I cannot make a compelling argument that we are not going to see significant price reductions in the upper end over the next several years.
LV Renter,
When saying it would be a larger bailout, what do you base that on? I will always be a proponent of waiving the recasts – it would save taxpayers tons of bailout money because you would see far fewer defaults.
I know that I said I wouldn’t ever bring up neg-ams ever again, because nobody has the patience to understand how they work, but this bugged me:
the homeowners who are holding option ARMs when the wave of resets hits won’t face as big a shock because interest rates have fallen, adds Fratantoni. “Interest rates have come down to the point where the resets that are going to occur are going to be a bit of a non-event,” he says. “Very few borrowers will experience the recast.”
The payment shock may be down to $700 or $800 per month on a $500,000, but that sounds like a lot to me.
Sub-Prime, Alt-A, whatever…
If home prices keep dropping, does the category of the mortgage even matter anymore?
Jim,
You’ve significantly understated the recast shock by calculating the new payment at 30 years instead of the remainder of the loan, which in your example is only ~26 years (since you specified July 2005 for the start rate).
Using the current MTA (from BankRate) 1.21 index + 3.025 margin = 4.226% for $575K over 26 years = $3040.15 per month.
That’s a payment increase of well over $900 per month, a percentage jump of nearly 45%.
BankRate.com FAQ: A typical pay-option ARM is recast on its fifth anniversary. At that point, the monthly payments rise so that the mortgage will be paid off in 25 years (30 years after the loan was taken out).
Significantly understated? By $200?? I was just hoping to bring to light that the thought of lower rates making the payment shock somehow tolerable was a stretch. Either $700 or $900 sounds painful to me.
I double promise I’ll never, ever (never, ever?) yes never ever bring it up again.
Do you guys have a blog? I’d like to visit.
Maybe I’m missing something, but delaying the reset/recast will not solve the problem long-term IMHO. The underlying economy stinks. Unemplyment is continuing to rise.
Out of work people can rarely pay their mortgages for long.
Banks can hold houses on their books for a while and will try to dole them out at a reasonable rate. But as more people are out of work, less people will make new mortgage commitments to buy up bank REOs.
Less buyers means lower prices.
“BankRate.com FAQ: A typical pay-option ARM is recast on its fifth anniversary. At that point, the monthly payments rise so that the mortgage will be paid off in 25 years (30 years after the loan was taken out).”
I know that the Downey option arms were for 40 years, and recast at 110%, so the devil in calculating these recasts are in the details in terms of making assumptions about payment shock.
Jim
Not sure if you are still reading this thread but here goes. The banks borrow money to lend out on mortgages. By suspending the recast they are continually extending credit. Many banks do not have this “capital” to extend. Which means that if they keep extending money (capital) eventually they will have none left.
Further, in todays finance world (we can argue the benefits of lack thereof), if investors do not see a chance of having their principle repaid they can cut off funding.
In either case the bank has lent out more money and does not have any left. Bailout or bankruptcy is the only solution. However, in the short term, borrowers can continue to go to Outback Steakhouse creating employment.
One other thing
Indymac, WaMu, and Wachovia all publicly stated they did not do subprime. They went out of business cause they ran out of money to lend to pick a pay customers.
Jim
Asking if I have a blog to visit was pretty defensive. I find your site highly informative and I have learned a lot from it. I just think on this particular item you are forgetting or are incorrect on the impacts. I hope you find my posts as informative as I find your posts.
I am defensive about the neg-am topic because people don’t want to listen about how they work, and how the amount of neg-am, while excessive in the beginning, narrows every year, and eventually turns to positive amortization. Nobody wants to hear that part.
I guess you can say that lenders are “extending credit” when a borrower chooses to make a smaller-than-full payment, but there is no money given from bank to borrower in that moment.
I’m not forgetting or incorrect.
Thanks for replying to me
But the bank pays out their lender the money. the banks need to pay the government 5% on their preferred shares. When it borrows from private markets it pays an even higher rate. Hence the banks run out of money and the large bail out.
The other problem is that many of the pick a payments were even more egregious look at this example in Bloomberg
http://www.bloomberg.com/apps/news?pid=20601109&sid=aQ_ZgC75Zfyw
“”””””””””””””””””””
June 11 (Bloomberg) — Shirley Breitmaier’s mortgage payment started out at $98 when she refinanced her three-bedroom home in Galt, California, in 2007. The 73-year-old widow may see it jump to $3,500 a month in two years.
Breitmaier took out a payment-option adjustable rate mortgage, a loan popular during the housing boom for its low minimum payments before resetting
“””””””””””””””””””
Should we the taxpayers extend money to CMAC (The current loan holder) ad-infinitum so that Shirley can continue to pay $98
jim, you run a very informative site.
along the neg-am topic, wouldn’t neg-am only turn positive if you start cutting into the principal? i think the only way to do that is via lowering the actual interest rate on the loan (but the bank wouldn’t make money), or reducing the principal via higher payments, lump sum payment, or cutting the loan pricipal (i.e. bank forgives part of the loan, or foreclosure). the only scenario that seems to make sense in this economic environment is foreclosure. Although i’m sure that some, especially in ‘higher end’ areas, will be able to survive a recast.
The minimum payment, based on the teaser rate, increases every year, and eventually surpasses the actual fully-indexed payment due to the natural fluctuations in market rates.
Oh wait a minute Jim, rates have nowhere to go but up!
The minimum payment will catch up, someday.
Where these broke down is when the Tan Man tinkered with the terms.
When World, Home, and Great Western Savings and Loan rolled out these loans, the recasts were at 10 years or 125%. John Wayne is rolling in his grave at the greed of WaMu, Countrywide and others who tweaked them to 110%/115% or 5 years. It makes the loans unbearable – the recasts are inevitable.
Did you see the analysis that said Wachovia’s portfolio from World was likely to be tolerable? It’s because they kept the 10-year/125% terms, they never changed them.
LV Renter,
Thanks for hanging in here.
The other tweak of the neg-ams was to lower the teaser rate – from the article:
Her payments started at 3/8 of 1 percent
Back in the day, the teaser rate was within sight of the fully-indexed rate. In the 1990s when I was refinancing 100s of these, the start rate was 3.95%, and fully-indexed rate around 6-7%.
Starting at .375% creates too big of gap, instead of 2-3%, having it at 5-7% causes a huge and insurmountable neg-am.
And no, I don’t think we should give the lender money to survive. There are two answers as to how they can handle the neg-am recasts:
1. Taxpayers pay money.
2. Waive recasts.
I will vote for #2 every time.
The loan is so misunderstood that even the lenders are ignoring #2.
They should have a national press conference and have somebody explain how they work to Obama, the Fed, and the lenders. I have sent to the White House and to the Treasury my idea on it, but no callbacks.
You know Jim, your last post strikes me of something. I recall how in cases of elderly or poor persons where foreclosure resulted in the early 2000’s the theme from the Government was one of “you should understand what you’re getting into, don’t call us!”..
The best Government money can buy.
You say 1/6 the volume — that’s about 16%. For homes priced >700,000 you need at least 150,000 of household income. What is that, 2-5% of the population that would qualify?
In these terms, 1/6 of the volume looks downright scary.
Your guess of 2-5% of population over 150K is wrong.
Nearly 12% of households in San Diego have incomes exceeding 150k !
11.9% of City of San Diego households
11.6% of County of SD households.
Significantly understated? By $200??
LOL! Only a Californian could consider $200/mo a trifle.
Look at it this way… the % difference between $2900 & $3100 is greater than the % commission collected by Realtors for hooking’em up! 😉
p.s.: No blog here either. Can’t compete with you pros (and your prose)!
“Nearly 12% of households in San Diego have incomes exceeding 150k !”
Exclamation points asside, 12% is still less than 16% (25% less, in fact) and the 16% figure stated by the other poster was a national average. I presume the concentration of Jumbo option ARMs is higher in San Diego than it is nationally.
U.S. Household Income Distribution
>$150,000 = 5.8%
You’ve gotta do apples to apples. If Alt-A Jumbo Option wave = 16% of total volumes Nationally (subprime + Alt-A Option), then you have to compare it to national household income.
Did you see the analysis that said Wachovia’s portfolio from World was likely to be tolerable? It’s because they kept the 10-year/125% terms, they never changed them.
What happens after 10 years?
At that point, the borrower who thought a loan was unbearable when it was 105% of the initial loan amount, now owes 125%. How does putting off the recast make them better able to afford the loan after 10 years (with a higher loan amount, amortized over a shorter period of time) instead of five (with a lower loan amount, amortized over a longer period of time)?
Back when these were civil, the minimum payment would catch up with the fully-amortized payment in 2-4 years. Then the amount of neg-am was lower, and at times positive, when the minimum payment exceeded the fully-indexed payment. With enough of those pos-am payments the balance would be going down, causing the reset to hopefully be tolerable.
If the government’s bailout plan leads to hyper-inflation and much higher rates that stick, then there will be problems, because the pos-am moments will be fleeting.
Part of the reason that banks are not coming clean on these loans is because of their creative accounting. They have been logging as income the fully amortized payments! They can only do this for so long. They are concerned about the short term, quarter to quarter. They aren’t looking forward, and even when they do, they’re using models that drastically understate the potential problems of price declines and unemployment.
The headline news lately has been telling the average person that things are getting better or that we’re nearing a bottom. Most of the statistics they point to are relative to the previous month rather than year, and they’re not taking into account seasonality. However, if enough people buy into the notion that the recession is coming to an end and banks are stable since they’ve passed the stress tests and have payed back the TARP money, they could become incredibly peeved if said banks get another bailout.
I think there could be another hit to consumer confidence (especially when it comes to housing) after this spring/summer bounce. Rising NODs and REOs will really pick up steam and prices could erode much faster in the nicer areas this fall/winter. If confidence does become shaken again it could take a very long time to rebuild it and with a steady flow of NODs and REOs for years to come, even if RE bottoms out, it will undoubtedly drag along there for a very long time…
Jim
I think I see our difference of opinion. I believe you see the foreclosure as the bank taking as the only loss. I see the bank receiving a margin call (ala Lehman, Bear Stearns, and Wachovia) as another possible loss. The bank does not have unlimited access to cash (Hence the TARP) and are borrowing the money they lent out. They are often borrowing at 5% (TARP preferred share rate). They probably also borrow a lot from foreign sovereign wealth funds.
Therefore when the recast is postponed indefinitely the homeowner does not default, but the bank runs out of money and defaults to its lenders (this happened to Wachovia). Then the government (or in Wachovia’s case stupid Wells with the final gov’t bail out TBD) bails them out.
I like to think of it as rearranging chairs on the titanic. If someone lends out a lot and receives back very little sooner or later there is trouble, and in the case of banks the government/taxpayers end up covering the loss.
In short if you lend out a lot and get paid back a little (as a contracted forebearance or foreclosure) there will need to be a bailout.
I hope you see my point, if not I agree to disagree and thank you for letting me post my contrary opinion.
Lastly the good old days when the min due on a pay option ARM was only a 250bps spread and the min due could adjust to the fully amortized payment in three years. I think all we have of that is memories.
Another thought, from the perspective of the lender/bondholder…
If the govt effectively bans foreclosures by forcing lenders to alter these contracts (extending duration and reducing interest rates), it could cause some pretty severe losses on the lenders’ side, especially if we are in a rising-rate environment.
Neg-am mortgages (and all ARMs, for that matter) are designed to shift the risk of rising interest rates onto the borrower, instead of the lender. This is why we see more ARM loans being issued in a low-rate environment, and FRMs issued in a high-rate environment.
When a lender buys a mortgage bond with “neg-am” terms, they are accepting a below-market rate up front because they intend to make up the difference over time, when neg-am payments are shifted to fully-indexed + margin payments. At that point, they intend to earn this rate not only on the initial loan, but on the additional amount then owed due to negative amortization. As negative amortization piles up, so do the assets of the lender (what once was a $100K asset becomes a $125K asset that is expected to earn a fairly high rate becase the caps and margins tend to be higher on neg-ams than FRMs issued during the same period). In other words, the income/profit is back-loaded.
If the duration of these loans is extended from 30 to 40 years, and lenders are forced to push-back the recast dates, with rates held to below-market levels for an extended period of time (with no guarantee that the borrowers will **ever** be able to pay off the loans), I imagine the value of these bonds would drop through the floor, no?
Who would ever want to make these loans or buy them in the future?
Without “mark-to-fantasy” accounting, this would severely hamper the banking/lending industry, as far as I can tell. Perhaps this is why they eliminated mark-to-market accounting for these loans.
Anyway…just another perspective.
Ca renter
For banks that hold the loans they would report pretty healthy profits in the short run as they keep accruing the fully indexed rate. If these loans are packaged into bonds those bonds would drop in value a lot, but as you note mark to fantasy accounting would postpone any losses.
However in the long run the rearranging of shares on the titanic would be disastrous. I think the hope is that banks will make enough money elsewhere (while the government provides TARP in the short run) to cover these losses. Time will tell.