The first wavelets of a long-dreaded tsunami of new defaults are washing up on the shores of California, Nevada and other markets where prices soared during the housing boom, bringing the nightmare of foreclosure to higher end neighborhoods that rarely see “bank-owned” yard signs.
The defaults result in part from the recasting of a loan type called Option ARMS that were marketed in areas where prices were soaring during the boom. Option ARMS allowed move up buyers to get into properties they could not otherwise afford, properties that they hoped would rise in value and provide the equity necessary to refinance. 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.
Many buyers, caught up in real estate mania, ignored or failed to appreciate the risk involved. Values fell instead of rising, leaving Option ARM borrowers underwater and not time is running out, as the five year recasting deadline arrives and monthly payments, especially for those who chose not to pay down any principal, are soaring.
Option ARMS accounted for as little as 0.5 percent of all mortgages written in 2003, but that shot up to at least 12.3 percent through the first five months of this year, according to FirstAmerican LoanPerformance. And while they made up at least 40% of mortgages in Salinas, Calif., and 26 percent in Naples, Fla., they’re not just found in overheated coastal markets: Through March 31 of this year, at least 51 percent of mortgages in West Virginia and 26 percent in Wyoming were option ARMs. More than $750 billion of option ARMs were originated between 2004 and 2008.
Now recasts are starting to come due for the first wave of option ARMs and there is some evidence the first wave of defaults is ahead of schedule. 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 and would not abate until 2012. Borrowers will find themselves paying an additional $1,053 on average each month. Fitch also found that many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules — often to the astonishment of people who thought the low installments were fixed for at least five years. In July, about 40 percent of borrowers with option ARMs were already delinquent, and “many” of the others will start missing payments before their obligations change, according to analysts at Barclays.
Fitch also found that many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules — often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can’t count on rising equity to bail them out. What’s more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk.
A new rash of high end defaults is sweeping the nation and Option ARMS are playing a major role. An analysis of recent defaults in the Bay Area by DataQuick suggest that high end defaults are rising fast, many of them Option ARMS. In communities where median prices top $1 million, about twice as many households received default notices from January to September as in the same period in 2008, and the largest percentage increases for defaults in the Bay Area occurredin pricier communities. Nationwide, homes in the top third of local housing values accounted for 30 percent of foreclosures in June, compared with 16 percent three years earlier, according to real estate Web site Zillow.com.
“The question is, could this be the beginning of something that gets a whole lot worse?” said Andrew LePage, an analyst with DataQuick told the San Francisco Chronicle. “The distress in the high end right now is important to watch; it helps explain why we have more sales (of high-end homes). More distress means more-motivated and more-realistic sellers. We’re just starting to find out whether the riskier loans that were not subprime will come back to haunt us.”