Mortgages: Option ARMs Are the New Subprimes

Here’s a sign of changing times — not necessarily for the better. The WSJ reports that Option ARMs are now performing worse than subprime.

From the WSJ article:

For the third straight month, option adjustable-rate mortgages are generating proportionally more delinquencies and foreclosures than subprime mortgages, the scourge of the U.S.

Option ARMs were typically issued to creditworthy homeowners and allow borrowers to make a range of monthly payments. The payment options include a partial-interest payment that adds the unpaid interest to the loan’s balance. On many such loans, balances have risen while values of the underlying properties have plummeted amid the housing crisis.

As of April, 36.9% of Pick-A-Pay loans were at least 60 days past due, while 19% were in foreclosure, according to data from First American CoreLogic, a unit of Santa Ana, Calif.-based First American Corp. In contrast, 33.9% of subprime loans were delinquent, with 14.5% of those loans in foreclosure, the figures show.

As you can see from the chart above, this is kind of disconcerting since these loans are just beginning to be recast. We haven’t even started to deal with this problem and their already cratering. I suspect that many of the borrowers are just throwing in the towel as they recognize how truly far under water they are. Do the math and figure out what 30% price depreciation combined with 10% negative amortization does to your equity position. Not pretty!

Then throw in a new amortization schedule at market rates on a 25 year term and you can quickly see that there is no feasible way out of this quagmire short of either massive foreclosures or massive modifications. We aren’t talking about starter homes either, folks. These loans were used by the overreaching middle class to buy the McMansions. Hold your fire if you want to trade up, the deals are coming.

The article in the Journal names Wells Fargo (WFC) and JPMorgan Chase (JPM) as being heavily exposed to this sector. True, both bought banks that had big portfolios of this junk. But there’s a big difference in the portfolios.

JPMorgans comes from WAMU (WM) who did a lot of stated income deals with fairly low down payments. They cap out at neg ams of 110% generally. Big problems with this portfolio. Wells on the other hand bought Wachovia which bought their portfolio from World Savings. Most of these were done at 75% to 80% LTV and don’t cap out and require a reset until they reach 125% LTV.

Perversely, World was conservative in terms of the equity it demanded going in but pretty liberal in terms of the amount of negative am they would allow. Net, net they probably have a less exposed portfolio than Morgan.

The one thing you can expect is that there will be some sort of massive bailout of these loans. The people who used these mortgages to buy their homes have more political clout than the subprime folks. They have some levers to pull so expect to pay for their mistakes.

Comments

[ain't no fo...:]

Many of these people consider themselves "renters" these days. Let's say you bought the home in FL when you and the spouse were both working in mid 2005. The house cost $450K and you put down 5% and picked the partial interest payment plan. So you have a principal amount of $427,500 and maybe a monthly payment of $1000 which is great, almost like rent, because you're living large and houses in FL are ratcheting up in market value weekly... 10% to as much as 45% a year in southwest FL (Cape Coral/Ft Myers/Naples).

Fast forward 4 years and the market has crashed. That market value on the house is now maybe $230,000 if you're lucky, and because of the negative amortization your principal on the mortgage is now up to maybe $480,000, maybe more. You're in the hole $250,000, maybe more and the mortgage is going to recast in about a year.

Oh yeah, and either you or your spouse just lost your job this spring and the other job is looking iffy, since its now a 30/hr week deal instead of 40, and maybe you'll lose your benefits like medical if it gets cut back further.

So now its tough to pay the $1000/mo mortgage payment, and you KNOW that when this baby recasts in 2010 the payment will be up to well over $2000/mo on a market value that is 1/2 the principal owed.

Like I said, you're just paying rent right now, if you're still even bothering to pay anything, because you know you're just a renter marking time and as soon as that recast comes through you're long gone and hard to find.

Or hoping that your mortgage paper work is so lost in a bunch of vintages and tranches on CDO's spread over every country in the world that the bank that comes to foreclose won't be able to prove it has title and you can keep "renting" the house for years while it goes through the courts.

Multiply that by a couple million Option Arms, factor in a U-3 unemployment rate that will hit well over 10, maybe 11% (or more) in the next 18 months, a few million Alt-A's in trouble, many prime and jumbo primes in trouble, a CRE market that is about to get nailed, some credit card "issues" and a middle class consumer who has that "thousand yard stare" as he hides under the sheets for the next 5 years trying to recover, and, well, you get my drift.

Jul 13 12:39 PM

[Tom Lindmark:]

Stop being so optimistic!


On Jul 13 12:39 PM wpdragon wrote:

> Many of these people consider themselves "renters" these days. Let's
> say you bought the home in FL when you and the spouse were both working
> in mid 2005. The house cost $450K and you put down 5% and picked
> the partial interest payment plan. So you have a principal amount
> of $427,500 and maybe a monthly payment of $1000 which is great,
> almost like rent, because you're living large and houses in FL are
> ratcheting up in market value weekly... 10% to as much as 45% a year
> in southwest FL (Cape Coral/Ft Myers/Naples).
>
> Fast forward 4 years and the market has crashed. That market value
> on the house is now maybe $230,000 if you're lucky, and because of
> the negative amortization your principal on the mortgage is now up
> to maybe $480,000, maybe more. You're in the hole $250,000, maybe
> more and the mortgage is going to recast in about a year.
>
> Oh yeah, and either you or your spouse just lost your job this spring
> and the other job is looking iffy, since its now a 30/hr week deal
> instead of 40, and maybe you'll lose your benefits like medical if
> it gets cut back further.
>
> So now its tough to pay the $1000/mo mortgage payment, and you KNOW
> that when this baby recasts in 2010 the payment will be up to well
> over $2000/mo on a market value that is 1/2 the principal owed.<br/>
>
> Like I said, you're just paying rent right now, if you're still even
> bothering to pay anything, because you know you're just a renter
> marking time and as soon as that recast comes through you're long
> gone and hard to find.
>
> Or hoping that your mortgage paper work is so lost in a bunch of
> vintages and tranches on CDO's spread over every country in the world
> that the bank that comes to foreclose won't be able to prove it has
> title and you can keep "renting" the house for years while it goes
> through the courts.
>
> Multiply that by a couple million Option Arms, factor in a U-3 unemployment
> rate that will hit well over 10, maybe 11% (or more) in the next
> 18 months, a few million Alt-A's in trouble, many prime and jumbo
> primes in trouble, a CRE market that is about to get nailed, some
> credit card "issues" and a middle class consumer who has that "thousand
> yard stare" as he hides under the sheets for the next 5 years trying
> to recover, and, well, you get my drift.

Jul 13 12:50 PM

[CoverIsBetter:]

Bailout? What kind of bailout? What "levers"?
The people started walking away in foreclosure. The banks started to fail. We bailed out the banks. The banks are paying back the TARP. Where do we go from here? Re-TARP the banks?

We need to re-employ the people. And make working socially acceptable to non-immigrants. Globalization and workplace evacuation by the middle class created the personal-fitness-train... lifestyle. So glad to see that unwind. But we need a 1980's style corporate boost and some inflation to put some of this debt behind us.

Jul 13 12:52 PM

[ain't no fo...:]

sorry... I'm just mistur happy, whistling while I work!


On Jul 13 12:50 PM Tom Lindmark wrote:

> Stop being so optimistic!

Jul 13 01:12 PM

[REITBull:]

To make things worse, I believe the World Savings pay option allowed a CLTV of 95% at one point. My memory is a little fuzzy on this though.

Jul 13 04:43 PM

[Mark54:]

My first mortgage was an option ARM and the broker selling me the on the loan had an interesting story how this product started. He stated the the option ARM was first created by Wall Street bankers that wanted a mortgage that mimicked their cash flow during year. They wanted to pay interest only (or 0) while they were being paid their meager base salary and then catch up on the principal after they were paid their bonus. Like any out-of-the-box financial product, the option ARM has a place with a subset of consumers but does not merit marketing it to the general population.

Jul 13 06:17 PM

[Trane250:]

The political notion of "laissez-faire" as practiced by the Bush regime is what's behind this mess. By golly gee, if the median price of a house in Orange County, CA is $725,000, then that's the true price because the "free market" set it. Therefore, the Pick-a-Pay mortgage, developed by financial engineers that allowed people to buy homes they couldn't otherwise afford is perfectly OK because the "free market" spawned its creation.

Jul 14 09:34 AM

[ivor:]

"We haven’t even started to deal with this problem and their already cratering"

Absolutely abysmal grammar here. I fear for the future of journalism if proof-reading is no longer taking place

Jul 14 11:27 AM

[Tom Lindmark:]

Duly noted. I wrote this one in too much of a rush and didn't proof it as I should have. Thanks for the not so gentle rebuke.


On Jul 14 11:27 AM ivor wrote:

> "We haven’t even started to deal with this problem and their already
> cratering"
>
> Absolutely abysmal grammar here. I fear for the future of journalism
> if proof-reading is no longer taking place

Jul 14 12:36 PM