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If there is any slight comfort to be taken from today's record-breaking mortgage delinquency numbers from the Mortgage Bankers Association, it's that there are early signs that the option ARM nightmare may not be as bad as many feared.

Delinquencies: Trading One Nightmare for Another

If there is any slight comfort to be taken from today’s record-breaking mortgage delinquency numbers from the Mortgage Bankers Association, it’s that there are early signs that the option ARM nightmare may not be as bad as many feared.

Option adjustable rate mortgages gave borrowers a choice of payments each month. They were particularly popular in high cost markets like Southern California. They allowed move up buyers to get into properties that would hopefully rise in value and provide the equity necessary to refinance. Except the market didn’t keep rising, it fell like a rock.

These loans also carried a feature called “negative amortization.” If the homeowner opted to pay less than the full monthly amount (as virtually all did), the difference was tacked onto the principal. When the loan recasts in five or 10 years, borrowers will find themselves locked into a new, much higher, set monthly payment.

Those recasts are starting to come due for the first wave of option ARMs. In a highly publicized report last September, Fitch Ratings predicted roughly $29 billion worth of loans would recast to higher monthly payments by the end of 2009 and an additional $67 billion would recast in 2010. Borrowers will find themselves paying an additional $1,053 on average each month. Fitch predicted delinquencies on option ARMs would more than double, and option ARM defaults would likely spread the foreclosure plague into higher priced neighborhoods, because many borrowers leveraged the very low minimum monthly payment to buy more expensive homes. To make matters worse, only 17 percent of option ARMs written from 2004 to 2007 required full documentation.

One of those raising the alarm last fall was William Longbrake, retired vice chairman of Washington Mutual, which collapsed last year and was one of the biggest originators of option ARMs. “The next wave (of foreclosures) is coming next year (2009) and in 2010, and that is primarily due to these pay-option ARMS and the five-year, adjustable-rate hybrid ARMS that are coming up for reset,” he told MSNBC.

So far-keep your fingers crossed-the option ARM nightmare looks to be significantly less scary than feared, at least through the first quarter, according to the MBA survey.

Foreclosure actions were initiated on 1.37 percent of first mortgages during the first quarter of 2009 and the seasonally adjusted delinquency rate was 9.12 percent of all loans outstanding as of the end of the first quarter of 2009, up 124 basis points from the fourth quarter of 2008, and up 277 basis points from one year ago. That seasonally adjusted rate is the highest in the MBA’s records going back to 1972.

“In looking at these numbers, it is important to focus on what has changed as well as what continue to be the key drivers of foreclosures. What has changed is the shifting of the problem somewhat away from the subprime and option ARM/Alt-A loans to the prime fixed-rate loans. The foreclosure rate on prime fixed-rate loans has doubled in the last year, and, for the first time since the rapid growth of subprime lending, prime fixed-rate loans now represent the largest share of new foreclosures. In addition, almost half of the overall increase in foreclosure starts we saw in the first quarter was due to the increase in prime fixed-rate loans. More than anything else, this points to the impact of the recession and drops in employment on mortgage defaults,” said MBA Chief Economist Jay Brinkmann.

Looks like we are trading one nightmare for another. Call them GOOFFs-for Good Old Fashioned Foreclosures. Lay-offs, bankruptcies, companies going out of business-these personal financial crises caused by economic factors beyond the borrowers control are the original causes of foreclosure and the most difficult to address. The Administration’s program can’t help when the borrower is unemployed. Nothing works until the borrower gets a new job, which is not such an easy thing to do in parts of Michigan and Ohio today.

“Looking forward, it does not appear the level of mortgage defaults will begin to fall until after the employment situation begins to improve. MBA’s forecast, a view now shared by the Federal Reserve and others, is that the unemployment rate will not hit its peak until mid-2010. Since changes in mortgage performance lag changes in the level of employment, it is unlikely we will see much of an improvement until after that,” said Brinkmann.

So there it is. The rate of foreclosures is now linked tightly to the unemployment rate. Foreclosures will continue to flood inventories and housing markets won’t improve until the overall economy gets better and people can find jobs.

It could have been worse. At least the option ARM nightmare hasn’t arrived-yet.

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