From bloomberg.com:

This was the year thousands of U.S. homeowners with option adjustable-rate mortgages were supposed to default as their payments spiked. Low interest rates and a surge of early delinquencies mean the numbers probably won’t be as bad as forecast, softening the blow to a housing market where prices have resumed falling.

Monthly payments on option ARMs reset after an initial low- rate period, usually five years, and researchers at CoreLogic Inc. in Santa Ana, California, estimated in 2009 that such recasts would peak at 54,000 a month in August of this year. In a 2006 cover story in BusinessWeek magazine titled “Nightmare Mortgages,” George McCarthy, a housing economist at the Ford Foundation in New York, compared the looming resets to a neutron bomb.

“It’s going to kill all the people but leave the houses standing,” he said at the time.

What he and other analysts didn’t anticipate was that so many option ARMs would go bad before resetting, and that interest rates would stay low enough to minimize the impact of the adjustments on borrowers who are making their payments. Still, a model developed by JPMorgan Chase & Co. analysts predicts that 70 percent of remaining option-ARM loans that were bundled into bonds will eventually default.

About $600 billion of the loans were made from 2005 through 2007, according to industry newsletter Inside Mortgage Finance. Of those packaged into bonds, some 20 percent have been liquidated at losses to investors, and almost half of the remaining ones are at least 30 days delinquent, in foreclosure or have been seized by lenders, according to data from JPMorgan.

“It’s not that option ARMs weren’t a bad way to finance homes, it’s just that the disaster already happened before the resets,” McCarthy said in a telephone interview last week.

The prospect of fewer defaults is a plus for the housing market, which was burdened by 2.2 million foreclosed homes as of Dec. 31, according to data from Lender Processing Services Inc. in Jacksonville, Florida. The S&P/Case-Shiller index of home values in 20 cities fell 1.6 percent in November from a year earlier, the biggest decrease since December 2009, the group said Jan. 25. The gauge remains 30 percent below its 2006 high.

Loan Modifications

Lenders and servicers are seeking to limit losses by modifying loans. Terms on about 20 percent of option ARMs have been revised, sometimes with a switch to a fixed rate, said Michael Fratantoni, vice president of research at the Mortgage Bankers Association, a Washington-based trade group. JPMorgan, Bank of America Corp. and Wells Fargo & Co. hold the biggest portfolios of option ARMs.

About half of the loans issued from 2003 to 2007 remain outstanding, he said.

For the remaining homeowners, payment increases will be limited to 30 percent to 40 percent, Barclays Capital Inc. estimated in a Jan. 7 report. Some borrowers are seeing their bills go down, lenders including Bank of America say. Analysts a few years ago were forecasting that payments for some borrowers could double.

“Of the borrowers who are still paying, the recast will not be a big deal,” Fratantoni said. “It’s not at all what people anticipated.”

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