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As traders we know that when Main Street latches onto something, it usually means the top. Growing foreclosures have been one of the biggest concerns of Wall Street and with real estate brokerages now giving Foreclosure Bus Tours, it leads us to wonder whether foreclosures have hit a peak.

According to the following ARM schedule published by Deutsche Bank, resets of Adjustable Rate Mortgages are expected to reach a peak in 2008. (Click images to enlarge.)

However the Federal Reserve has already cut interest rates by 200bp, which means that the interest rates that these mortgages will reset at could actually be the same or lower. According to my friend Mike Shedlock:

“Most of the 5/1 ARM’s I reviewed that originated in 2003 had start rates between 4% and 5.125%.”

“3-1 LIBOR based ARMs initiated in 2005-2006 would also likely reset lower and again with the same caveat repeated about day-to-day conditions, lender specific conditions, etc.”

ARMs are based on an index rate, typically 1-year treasuries or 1-year LIBOR, plus a margin amount (e.g. the treasury rate + 2.75%).

Current rates as of April 8 are:
1 Year LIBOR 2.60
1 Year US Treasury 1.68

Taking the high interest rate of the mortgages initiated in 2003 (which are the ones set to be reset in 2008), the reset rates should range from 4.43 to 5.38%, only slightly higher than 2003 levels,

A glance at this Denver neighborhood indicates that those who are vulnerable to foreclosure may actually already be in foreclosure. Although I still expect more homeowners to default, the rate of foreclosure growth should begin to slow as ARM resets are no longer as painful as they use to be, particularly if the Federal Reserve continues to cut interest rates.

Source: USA Today (Link to Denver Foreclosures)

Although I do not expect the US economy or the housing market to begin to recover until the fourth quarter, an improvement in the pace of foreclosure growth could be the first step towards a recovery.

Source: Signs That Foreclosures May Be Peaking