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Thread: potential Mortgage Meltdowns ... with numbers

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    Default potential Mortgage Meltdowns ... with numbers

    ""Borrowers think they can always refinance. That is not always a safe bet." This is a point few understand. Also when you get fore closed upon the bank will give you a 1099 form for the difference on what you owe and what they sold the home for. Put the fore closure fees on top of all this and you have some significant debt.

    Hybrid Loan Time Bomb
    The HeraldTribune is reporting the clock is winding down on the Hybrid Loan and Sub-Prime mortgage time bombs.

    Starting in 2006 and accelerating into 2007, as much as $2.5 trillion worth of the fancy mortgages called "hybrids" are coming to the end of the free-lunch part of the deal. Economists are still trying to put numbers on this reset factor, particularly when it comes to the riskiest home loans, referred to as "sub-prime."

    "We don't have enough data to know how big a problem this will be," said David Berson, chief economist at Fannie Mae, the nation's largest mortgage packager.

    The ticking clock

    Sarasota's John Barron is typical of the new crop of homeowner-investors. He and his wife, Lauren Wood, are sitting on big profits at two 2004 purchases in the up-and-coming Gillespie Park neighborhood, close to downtown Sarasota.

    But the couple made their big moves using ARMs that are about to be reset. If they don't act soon, their monthly bills will rise by hundreds of dollars per month. They used two separate three-year, interest-only, adjustable-rate mortgages from SunTrust Bank to buy the homes within the past two years.

    "Besides the two ARMs, we also took out a home equity line on the Seventh Street house to put down a deposit on the Fifth Street house. There was no cash that we had in our pockets to put down on the Fifth Street house. All we had was our shining credit record. And the faith that the banks have in this real estate market that allows you to borrow 100 percent."

    Barron and Wood have a lot of company, says Paul Kasriel, chief economist at Chicago-based Northern Trust.

    With possibly $2.5 trillion in household debt that is going to be repriced higher "the household debt-service ratio is bound to climb to new highs," Kasriel wrote last month. "Asset bubbles are characterized by cheap credit. Usually what bursts a bubble is higher cost of credit, because that is what inflates the bubble, is cheap credit."

    At Sarasota's Integrity Mortgage Group, ARMs have far and away taken over as the most popular. Five years ago, there was only an occasional one-year or five-year ARM. "Out of 200 loans you'd do 10 adjustables," Integrity President Jason Thurber said. "In the last year, I've probably done five fixed-rate loans, 30- or 15-year, out of 150 loans. So all the rest are some kind of hybrid."

    The big picture looks similar, says SMR Research of Hackettstown, N.J., which regularly surveys lenders who make 90 percent of America's home loans.

    "I can say that the first half of this year, ARM share was 55 percent nationally," said SMR's George Yacik. "For the full year 2004, it was 50 percent." Making matters worse, it is the the sub-prime lenders issuing the most adjustable-rate mortgages. With those who participate in the survey, 80 percent of their loans were ARMs compared to 55 percent in the broader market.

    Fannie Mae looked at 2002-2004 loan data to determine what portion of the existing loan pool would be "adjusted," and when. Fewer than 10 percent of the conventional conforming loans will reset in 2006-2007, but nearly two-thirds of sub-prime loans will. That is because a large portion of the sub-prime loans are two-year adjustables, says Berson, the Fannie Mae chief economist.

    Berson offered a typical example of what the industry calls a "2-28," an ARM in which the interest rate is fixed for the first two years and then adjusts regularly for the next 28 to whatever index the loan calls for. The average yearly cap on this loan is 2.3 percentage points per year.

    Roughly speaking, a consumer's monthly bill could rise from $330 to as much as $1,425 to $1,755.

    Fannie Mae expects sub-prime loans to be reset en masse this year with that trend continuing into 2007.

    But over at the Mortgage Bankers Association, senior economist Michael Fratantoni is more interested in the five-year adjustables that were issued during the refi craze of 2002-03. That's a large crop that will sprout in 2007.

    "The estimate is that in 2007, more than a trillion dollars worth of hybrids are going to hit their first reset date," he said.

    That one chunk of hybrid loans represents 12 percent of the $8.8 trillion in single-family home loans outstanding nationwide.

    Like many ARM borrowers, Barron, the Gillespie Park buyer, is not really sure how much his payment will go up when the loans are reset. The new rate is a moving target. "Come year four, they adjust it based on the prime rate," he said. "It is like prime rate plus two, or, I can't remember exactly what the adjustment is."

    At Washington Mutual's Bee Ridge Road office in Sarasota, 25 percent of current applications are for option ARMs, says senior loan consultant Mike Bangasser.

    For customers with good credit, there is only about a half-percentage point difference between the 5.75 percent rate on an option ARM and the 6.375 percent rate on a 30-year fixed rate mortgage.

    So why bother with the ARM?

    This is the key: The minimum payment today on a $200,000 option ARM would be only $678, a little more than half the cost on a 30-year, fixed-rate loan. On that $200,000 loan, a 30-year fixed would be $1,248 per month in principal and interest. With the option ARM, there are three other payment choices: $958, $1,167 or $1,661.

    The $678 payment doesn't even cover all the interest, Bangasser acknowledged.

    He guesstimated that if somebody borrowed $250,000 on a typical option ARM and made minimal payments for five years they would be "going to be in the hole 15 percent to 20 percent of your original balance, meaning $285,000 to $300,000."

    "You don't have to have negative am," Grande said. "As long as you make that fully-indexed payment, you're fine. But most folks aren't doing that. They take the easy way out, get themselves in trouble."

    There is one more ingredient to add to this layer cake, and it is one that barely occurs to most borrowers today: What if someday, loans were difficult to get?

    "Consumers have become so accustomed to very liquid mortgage markets, where credit is available for almost any circumstance, that they are not aware this is unusual in the market," HSH's Gumbinger warned. "Somewhat tighter credit availability and somewhat higher interest rates are much more normal."

    "Borrowers think they can always refinance. That is not always a safe bet."

    It's hard to know where to start with this kind of nonsense. But people still insist there is no bubble. That this type of activity occurs routinely is clear evidence of a credit lending bubble. Given that the credit lending bubble has grossly affected home prices, it should be obvious there is a housing bubble as well. Day in and day out however, someone writes an article telling us why this time is different and how affordable housing really is.

    We have been talking about a possible "credit event" when these loans reset, so I guess we do not have much longer to see. It may not be a "big bang" however, as these loans are scattered throughout 2006 and 2007.

    It is amazing to me that people in these loans are nearly clueless as to what their loans might get reset to. Barron's loan adjusts to prime rate +2 or something like that but he "can't remember exactly what the adjustment is." Yikes that is 9.25%, on three properties! He has three 100% loans based solely on "shining credit" and someone stupid enough to make the loan. Perhaps a better way of stating it is some hedge fund or mortgage player or investor is stupid enough to take that risk for perhaps an extra 1/4 point or 1/2 point over treasuries. Is that a good deal? I think not and I fully expect to see some hedge funds and/or leveraged reits to blow up over it too."

    Mike Shedlock / Mish

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    God/dess montythegeek's Avatar
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    Default Re: potential Mortgage Meltdowns ... with numbers

    1. The article mistates the facts since the family in question is factually not "typical". The typical family does not have 3 houses and a $1million-$1.8 million exposure to real estate.
    2. Their risk is not able to be determined from the available facts. There is not mention whatsoever of income or the stability of it. Nor is there a mention of the home equity in the residence. There is also no mention of other resources or rental income. A quick look at the local paper showed rental rates for on 1-year leases fetching $1200-$1700 per month (2.5 times payments). Also they could be sitting on capital gains of up to $250,000 depending on location and dates of transactions.
    3. If they are not greedy the properties in question could be sold in 2-3 months easily. One alone could yield a capital gain paying 100% of the mortgage for 5 years. People are moving to Florida so real estate turns over quickly.
    4. Sarasota realestate is constrained by the cost of new structures since the stock is expanding quickly. I was in that area 7 years ago and there is tons of vacant land less than 10 miles away in any direction but west (Gulf). Like all Fla. towns there are also neighborhoods which can be gentrified and upgraded. There is no land shortage.
    5. The rates quoted are foolish hyperbole. Rates move "toward" prime plus, not to prime plus. A 2%/year cap could be refinanced today at a 5-1 arm interest only rate of 5.33% according to bankrate.com, and the Fed is within 0.5-0.75% of being done raising rates, so even if they waited their risk would be 6% or so not 9.25%.

    If they are not greedy AND stupid, they can easily refinance, sell one, (or both speculative properties) and get out with a solid capital gain. Of course, if they are stupid, they would have found another way to lose money other than real estate. I would never do what they did, but info not available makes it risky or not.

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    Featured Member scorpio's Avatar
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    Default Re: potential Mortgage Meltdowns ... with numbers

    It's all about cashflow. ARMS provide this, especial;ly on rental property, and what many don't realize is that if your ARM, expires, just re-fi and reset at the lower fixed rate. Mortgage brokers are very competative, so you should have no problem finding one who charges little or no closing costs. As long as you aren't constantly taking equity out, then even an interest only loan will preform.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    I don't really follow stats for the most part ( i guess that's kind of obvious). I just pay attention to what is going on around me. I like to keep it simple. I live in Mi. We are in an econmic down turn for many reasons ie GM, Ford, etc.
    From what i have noticed,here, the housing mark is headed for a down turn. The question is how far down at this point.
    Mortgage rates are going up. If the econmy, here anyway, continues as it is they will continue to rise. There are pockets of real estate that is way over valued. There have been alot of people that have tried to cash in on the housing boom. They have bought houses to fix up to resale. They can't sell them for what they are worth now. Many houses are just sitting on the market. These folks are strapped with two mortgages. Some of these are even hard to lease out. Also there are people with interest only loans in houses they cant really afford.
    I don't think Mi is isolated in this kind of situation. As with all down turns some areas are hit harder than others.
    I am a pessimist. I prefer to side with caution.
    Refinance isn't something people should fall back on. I will never understand why a family that plans on staying at a residence don't lock in at current rates. Most the time with refi there are closing costs. As far as places offering no closing costs I have always felt you get what you pay for. There is always a catch buried in the fine print.

    I think Melonie is right mortgages and the housing market are headed for a down turn. I just hope it's not as bad as I think it will be.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    What goes up must come down - the bubble will burst . The people with the arms must make a decision to sell their property isnt that why you work these deals for the most part - to get in and get out ( flipping ) and hope you can pocket some cash .I just could not let myself hang out there that far too risky at my age . My plan is in ten years sell my house and downsize and move to a different area ( about 45 miles from my present home ) .I am fairly certain that I will still make a sizable profit .

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    Default Re: potential Mortgage Meltdowns ... with numbers

    Refinance isn't something people should fall back on. I will never understand why a family that plans on staying at a residence don't lock in at current rates. Most the time with refi there are closing costs. As far as places offering no closing costs I have always felt you get what you pay for. There is always a catch buried in the fine print.
    Ok, so you lock in at todays 30 year fixed rate, and you pay 6.3%. Now keep in mind that the average family refi's or sells within 7 years. Now I lock in 4% with an interest only option. My payments are 30% less than yours on a monthy basis./ My ARM is locked for 3 years and then can increase or decrease a maximum of 1 point every 12 months. If everything went wrong, I will virtually break even with you, but if the market goes down or is stable, I will out perform you, while significantly increasing my cashflow, which could be used to lower other debt., Also, by doing a no cost refi, I get to skip a months payment. I have friends that only make 6 payments per year because they are always refinancing.

    to clarify how mortage pricing works, it is simple. A lender provides a rate sheet to a broker. I love it when someone askes me what the days rate is, because I say 1-10%, and it's true. To start, there is the wholesale bank rate, which pays the originator zero money. As the rates increase, so does the payout from the bank to the originator. So, taking a rate that is .25, or .375 higher (lender is paying out 1-2%), but paying no out of pocket costs makes sense. You can get a rate that is below the wholesale bank rate by buying down the rate by paying discount points.

    s far as the housing market declining,......no. It will slow down, it will come cack to earth (5-8% annual increases), but unless you are in a specialized speculative market like south Florida or Cali, housing will not decline.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    [QUOTE=scorpio]Ok, so you lock in at todays 30 year fixed rate, and you pay 6.3%. Now keep in mind that the average family refi's or sells within 7 years. Now I lock in 4% with an interest only option. My payments are 30% less than yours on a monthy basis./ My ARM is locked for 3 years and then can increase or decrease a maximum of 1 point every 12 months. If everything went wrong, I will virtually break even with you, but if the market goes down or is stable, I will out perform you, while significantly increasing my cashflow, which could be used to lower other debt., Also, by doing a no cost refi, I get to skip a months payment. I have friends that only make 6 payments per year because they are always refinancing.


    You are the expert as I can see here good info : But what I see here is that you are building no equity in your house and basically paying rent - Do you feel there is less risk with a locked in rate with P&I ? Keep in mind my plan is to stay in my home for ten years in which I will own my house free and clear .

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    Default Re: potential Mortgage Meltdowns ... with numbers

    Ok, so you lock in at todays 30 year fixed rate, and you pay 6.3%. Now keep in mind that the average family refi's or sells within 7 years. Now I lock in 4% with an interest only option. My payments are 30% less than yours on a monthy basis./ My ARM is locked for 3 years and then can increase or decrease a maximum of 1 point every 12 months. If everything went wrong, I will virtually break even with you, but if the market goes down or is stable, I will out perform you, while significantly increasing my cashflow, which could be used to lower other debt., Also, by doing a no cost refi, I get to skip a months payment. I have friends that only make 6 payments per year because they are always refinancing.
    All of this is true ... at this particular moment in time. However, for this to continue to be true in the future A. creditworthiness standards and interest rates need to remain sufficiently 'loose' such that people are still able to refinance at will under favorable terms, and B. real estate markets must retain sufficient pricing power and liquidity that people are still able to sell their houses at will without taking a significant loss on the principal/capital. Both of these conditions are 'unusual' to say the least when viewed in a 100 year historical context. However, if/when refi's under favorable terms become problematic for the majority of blue collar homeowners, and if/when current market prices for real estate are below the price that the property was originally purchased for, aaaooogah !

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    Default Re: potential Mortgage Meltdowns ... with numbers

    Curious J,
    The strategy that Scorpio outlines is valid and works under certain circumstances. If you take an interest only loan today at 4% and pay the additional payment equal to the normal p&i loan at a fixed 6.3%, you can pay down the loan fast enough that even after the rate goes up in year 4,5, 6 etc you can end up with more equity.

    The risk Scorpio is willing to take is the refinance rate risk. Say you borrow 100K according to his example (you pay principal volunarily to match the fixed coupon) and rates stop at 8%. If you can refinance for less at that time you have a lower principle and lower payment on th enew loan. If rates go higher and you cannot refinance for some reason over the interval you can end up with a higher payment and less equity after a few more years. It all depends on the path after year 5.

    He has more options than you because he sees it everyday and has a better chance of switching at an advantageous point because he can see it coming. One can build equity fast and have some protection against an upside by paying more in the early years of the loan if you are worried about that. It can and does work if you have enough discipline. If you pocket half of the discount over a fixed rate, the advantage disappears much sooner and the risk of high rates is the same if you cannot refinance.

    You can also (according to your goal) benefit by if you got a slightly higher rate which is locked in longer since you want to pay it off over 10 years. Everything depends on the spread between a 10-year rate and what you guarantee you will pay each month. A fixed rate loan cannot go up or down no matter what. An additional consideration is the after-tax cost and that opens up a whole other can of worms because interest is currently deductable but depends on your tax bracket and future tax bracket, If you do the math on an aftertax basis it moves a lot of stuff around, reducing some of the gains in scorps example early on, but possibly pushing it in his favor at a later date if rates go high enough.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    [QUOTE=CuriousJ]
    Quote Originally Posted by scorpio
    Ok, so you lock in at todays 30 year fixed rate, and you pay 6.3%. Now keep in mind that the average family refi's or sells within 7 years. Now I lock in 4% with an interest only option. My payments are 30% less than yours on a monthy basis./ My ARM is locked for 3 years and then can increase or decrease a maximum of 1 point every 12 months. If everything went wrong, I will virtually break even with you, but if the market goes down or is stable, I will out perform you, while significantly increasing my cashflow, which could be used to lower other debt., Also, by doing a no cost refi, I get to skip a months payment. I have friends that only make 6 payments per year because they are always refinancing.


    You are the expert as I can see here good info : But what I see here is that you are building no equity in your house and basically paying rent - Do you feel there is less risk with a locked in rate with P&I ? Keep in mind my plan is to stay in my home for ten years in which I will own my house free and clear .
    First of all, I don't pay P&I. It is a total waste of money, and there are alot of lenders that do not charge it.

    Second, remember that you pay very little principal in the first 5 years, so what difference does it make paying interest only? Also, If you pay bi-weekly, you further reduce your balance by about 20%

    Third, I pay inerest only. On my condo, I purchased for 129K 2.5 years ago, has increased in value to 155K today. This is a conservative increase. In the mean time, I have saved over $80 per month with the IO. I would rather have the cash flow than a slightly lower balance at the end. Also, keep in mind that on an ARM, the fixed period (usually 2-5 years) has a low start rate. Evn when rates were 8-9% in the late 90's, the start rates were 6.5%. So, even if rates go up, you can "reset" the lower rate by refinancing into an ARM. yes, it may be a hassle, but I spent the last 5 years paying a significantly less payment than you. You have to ask the question: Do I want my money now in the form of a lower payment/cashflow, or later in the form of equity. I want my money now, dammit!

    Mel broght up a good point when she questioned credit worthyness. If you mess your credit up, you certainly will have trouble refinancing in the future. Keep your nose clean.

    As far as paying your mortage off, why on earth would you wan't to do that? You lose a significant tax write off, and believe it or not, if you want to cash equity out later on a free and clear property, it will be much harder to get a loan. that's right, lenders penalise you since you have no mortgage payment history in the last 12 months. A better stratagy is to keep a loan to value ratio of 50%. This way you keep the write off, but have enough equity for emergencies. With an LTV that low, you could refi even without a job.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    Scorpio,
    You are usually right, but not this time. Based on a time trend of the real (inflation adjusted ) average single family house price which has a 3.9% cagr over the last 37 years you face a real downside risk of 10% on your initial purchase price or about 5% nominal price risk just to return to the trend. Your capital gains could easily go away at a trough in realestate prices for the next 10 years.
    You are now 33. In 35-6 years you will be retiring and living on a much rduced income. With no equity and a more typical 6% interest rate you face a $600/month interest payment which could be 25% of your nominal SS income if inflation stay below 2%. If it goes higher, you face a 700-800 payment, better than a pure renter, but not much. At your 50% max equity rule it is a much higher payment. there are tortoises and hares and your prospects are very harey.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    sorry Monty, I have realized and will continue to realize equity in my property. Paying interest Only has negligable effect on equity standing. Negative am loans are different, but unless you own a high appreciating property, those are dicey. Your numbers are of too long a time period, and a nationwide average is not applicable. Show me numbers for Chicago in the last 20 years and we can see what I really face.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    Quote Originally Posted by scorpio
    sorry Monty, I have realized and will continue to realize equity in my property. Paying interest Only has negligable effect on equity standing. Negative am loans are different, but unless you own a high appreciating property, those are dicey. Your numbers are of too long a time period, and a nationwide average is not applicable. Show me numbers for Chicago in the last 20 years and we can see what I really face.
    Scorpio,
    Your choice of time frames biases the answer in your favor. 1985 was a high real and nominal interest rate environment, not on equal footing with today's low rates. When I bought my first house the next year an adjustable mortgage was 10%. As rates go down the value of the property rises. To look at property values you have to compare comparable environments at each end. I already biased the answer up by using average prices since the average property is larger with more amenities than long ago. You only get one gimme. Be awrre you do face a tangible downside risk. dep[ite your optimism/ I do not believe the sky is falling, but to believe any investment is guaranteed is folly.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    The one thing you did not consider, Monty, is that I would not be owning properties more than 5-10 years. The average american moves every 7-10 years, and I also wouldn't hold investment properties any longer.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    Again, the underlying assumption that (re)refinancing will always be possible on favorable terms may soon be in for a 'paradigm shift'



    (snip)In the last two years, with mortgage lenders offering low teaser rates and so-called "no-doc" loans that don't require an income check, the market for these loans has shifted from affluent homebuyers to the middle-class buyer seeking more affordable payment options.

    "We're glad to see the agencies address this issue because the switch to higher risk mortgage lending has been quite dramatic," said Allen Fishbein, director of housing and credit policy at Consumer Federation of America. "A mortgage is not just about consumers being able to buy a home but being able to actually stay in the home that they purchased."(snip)


    To avoid misinterpretation, I agree with Scorp and Monty that it makes very good financial sense to buy the one house/condo which you plan to live in for many years - providing that you actually are building equity with every mortgage payment, and providing that your financing arrangements aren't subject to a huge future 'readjustment' that could potentially raise future monthly mortgage payments beyond your ability to afford making them.

    The potential 'mortgage trap' underlying this thread is that if a home buyer is dependent on 'creative financing' to get approval to buy their home, and if that 'creative financing' carries the possibility of monthly payment 'readjustment' some 2-3-5 years down the road, that the buyer is basically 'betting the house' that todays financial conditions will still exist in the future. However, it is also increasingly plausible that 2-3-5 years down the road when those 'creative' mortgage payments go up by 25-50+ percent, that lenders may not approve a re-fi (at least not a re-fi with affordable monthly payments), and that the housing market may have dropped significantly.

    Thus tightening lending standards plus a soft housing market may combine to 'trap' creatively financed homeowners in a situation where 2-3-5 years down the road they can no longer afford their 'readjusted' mortgage payments, they can't get approved for a re-fi with lower payments, and the auction/resale value of their house could be less than the actual amount they still owe under their creatively financed original mortgage. Put very bluntly, the future convergence of tighter mortgage lending standards plus a softening housing market equal a likely formula for bankruptcy for many of those current homeowners who depended on 'creative financing' to qualify for financing on a house that they could not afford to buy under 'conventional' financing, and which they may not be able to keep in the future once their 'creatively financed' monthly mortgage payments readjust upwards.
    Last edited by Melonie; 01-12-2006 at 04:55 AM.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    so we should all jus rent a trailor down by the river and play it safe? Mel, some people like to own their homes.

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    Default Re: potential Mortgage Meltdowns ... with numbers

    The all-time low for 5/1 ARMS was 4% in June 03. In Jumne 08 if it were repriced it would rise to 5%. The payment difference is less than $200/month on a 300K mortgage. A lender who let some one finance 1/3rd of gross income would have qualified anyone with income over 67K/year (assuming a high $5k property tax bill). If you cannot come up with $200/month on +40K/year income after housing expense, you have massive problems

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    Default Re: potential Mortgage Meltdowns ... with numbers

    so we should all jus rent a trailor down by the river and play it safe? Mel, some people like to own their homes.
    I refer you to my earlier post ...

    "To avoid misinterpretation, I agree with Scorp and Monty that it makes very good financial sense to buy the one house/condo which you plan to live in for many years - providing that you actually are building equity with every mortgage payment, and providing that your financing arrangements aren't subject to a huge future 'readjustment' that could potentially raise future monthly mortgage payments beyond your ability to afford making them."

    If you cannot come up with $200/month on +40K/year income after housing expense, you have massive problems
    Unfortunately, it's not only the housing expense ... it's increasing prices for food and gasoline and utilities, it's increasing medical costs, it's increasing state and local taxes, on top of the mortgage payment increasing $200 per month - while at the same time pre-tax income remains more or less stagnant. The problem is not merely trying to squeeze an extra $2400 per year out of discretionary income to cover a higher mortgage payment, it's trying to squeeze another $2400 mortgage + $1000 food + $1000 gasoline + $1000 utilities + $500 medical + $1500 taxes out of a $40,000 net income which is basically not increasing, while still carrying the original $9.600 mortgage and original $4,800 car payment and original $5,000 food and original $ 2,000 gasoline and original $ 2,000 utilities and original $5,000 taxes. At some point cash flow goes negative, at some of the bills don't get paid, and at some point tough decisions need to be made regarding which monthly payments must be reduced or eliminated.

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