compared to the time bomb of coming defaults by PRIME mortgage holders ...
(snip)"There really has not been much mentioned in the MSM about one of the Crazy Aunts, pay option ARMS, made almost exclusively to “prime” borrowers. The LA Times finally got around to writing a good article about them. One of the data points I was wondering about was mentioned, and that’s the number of Crazies who are making minimum payments. The answer is a rather stunning 75%. This means that negative amortization is piling on to pay option ARMs loan balances at the rate of 4-5% a year.
In fact, more than 75% of option ARM borrowers have been making only the minimum payments, analysts at Standard & Poor’s Corp. said last week.
As payment requirements are scant, delinquencies have been relatively contained to date. Since nobody has ever made any real attempt to discount the future beyond the three month old data released by financial firms, this Crazy Aunt has stayed in the attic. But behind closed doors she is ripping all the bathroom fixtures off the walls.
The initial low payments on option ARMs have kept a lid on serious delinquencies — 3.7% of all option ARMs, Standard & Poor’s analysts said in a report last week. That’s higher than before, but still low compared with the 6.3% delinquency rate on loans to good-credit borrowers with so-called hybrid ARMs, which have a low fixed rate for two to 10 years before becoming adjustable-rate loans.
Of course it doesn’t take rocket science to see that these are time bombs. Pay option ARMs almost always have two trigger points when they “suddenly” revert to regular amortization loans. At that point monthly payments will at least double. Those triggers are when the loan balance reaches 110% and 115% of the initial loan balance. I have never been able to locate the data on how many are 110s versus 115, so let’s just assume 50/50. If it’s 110%, you can look at the next chart, and see when 75% of the amounts will reset. 4-5% a year of neg am means 2-2.5 years for 110ers, and 3-4 years for 115ers. 75% making minimum payments from the 2005 group is $180 billion. Late 2008-2009 becomes the trigger for the 115ers, and starting late 2007 for the 110ers. But then comes the 110ers in the 2006 cohort, followed by the 115ers going into 2009. Some of the 2006 110ers will start triggering in late 2008. The amounts involved are not as much as for subprime, but more lethal to the lender, as the loan balance has increased significantly. And actually the later resets with 115% triggers will be even worse for the lenders, promising lousy recoveries."
Of course this is just the effect of the additional balances. Even the lagging housing price reporters like Shiller have finally been using 6.1% national price drops on their Big Chief writing tablets. In locales where neg ams are used aggressively it’s even more. So even using that ludicrous Shiller estimate, we begin to see just how underwater these loans are. And connecting the dots on affordability comes this from Christopher Thornberg on California prices.
By 2006, the cost of that same house doubled, to $540,000 — pushed by unbridled speculation fueled by unparalleled access to mortgage capital. But median income rose a paltry 15%. So today that same set of costs come to 60% of gross income.
Incredibly the minds like steel traps at Countrywide et al, or more accurately their financiers, have come to the realization that this just doesn’t add up, and have closed the barn door on the whole tawdry affair.
Had those guidelines been in effect previously, Countrywide recently said, it would have rejected 89% of the option ARM loans it made in 2006, amounting to $64 billion, and $74 billion, or 83%, of those it made in 2005.(snip)
As usual, Russ Winter has managed to provide an early warning for the next great 'stealth' risk factor to the US economy. Take a minute to digest his point ... that aside from the subprime borrowers who will be bankrupted by their ARM resets, there are also untold numbers of PRIME borrowers who are currently cruising along via not only paying a 'teaser' interest rate on their Pay Option ARM's, but who are also allowing the principal balance of their mortgage loan to increase via negative amortization due to making minimum payments on their Pay Option ARM's. This is happening at the same time that the market value of their collateral i.e. their house is also falling.
As Russ further points out, the Pay Option ARM's have provisions which force a reset in monthly payments when the outstanding principal balance hits 110% or 115% of the original mortgage - and that these forced resets will begin to occur in 2008 but will really start hitting in force in 2009. If you figure that 2009 real estate market values will have dropped by 10%-15% since the Pay Option ARM's were written in 2005-2006, and also figure that the amount of outstanding mortgage principal will have risen by 10%-15% due to 75% of Pay Option ARM borrowers making only minimum payments, this will absolutely lead to a situation where PRIME borrowers will face a situation where their mortgage payments will more than double at a time when they have a deep underwater situation in terms of negative equity (with many loans likely to be underwater by 20-30% ( = $100k-$150k-$200k on a median priced home).
The obvious conclusion is that by 2009 these PRIME borrowers will choose bankruptcy as the only means available to escape from their underwater mortgages with their IRA's / 401k's intact. The just as obvious implication is that banks and foreign lenders who thought that they were 'safe' by loaning / investing only in PRIME credit markets will also get smoked by mounting losses. And as Russ points out, while the dollar volume of total loans is less than subprime, the dollar volume of probable losses to banks and foreign lenders will be much higher due to the additional 10%-15% that negative am has added to mortgage loan principal thus gap between outstanding loan balances and recoverable value of collateral. This development will dwarf the fallout from subprime defaults / bankruptcies, and will ultimately be the end for under 20% down payments and 'affordable' loan interest rates on loans of all types for ALL would-be borrowers - subprime, Alt-A and prime.
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