I was a guest on CNBC’s Kudlow & Co. on Wednesday night. It’s always fun to be on the other side of Larry, who for some reason actually agreed with me and the other realist, Moneynews.com’s John Browne, on a number of points.
Usually I have an idea about the night’s topics so I can do a little research ahead of time. This night was no different, with one exception: I wasn’t expecting Larry to do a chart that showed how mortgage resets were about to fall off a cliff, suggesting happy days will soon be here again.
Had I known about it, I would’ve brushed up. Instead, I shut up and (novelty of novelties) listened — and was totally puzzled.
I wasn’t alone. “When they start talking about mortgage RESETS,” emailed Paul Jaber, a portfolio manager at the Perpetual Value Fund, “can you correct them and tell them the problem is RECASTS? They surely don’t know the difference…”
See, if you took out an option pay ARM loan in 2005 and bought a few properties like the hotshot 24-year old Southern California real estate mogul — on average you would be able to make 40 months of BELOW interest rate mortgage payments (I use the word payment loosely).
After about 40 months your 2% b.s. payment would make the loan grow to about 115% of the original amount and then — WHAMMO — your loan would recast to a 27-year fully amortizing mortgage. Your payments would go from $1,000 a month to over $3,000 and you would be walking around wondering, like “What is happening?” A good analogy is the three-year no-payment, no-interest Circuit City TV loan. The catch is that in month 37 you owe ALL back interest — usually about double the original charge.
The guys talking about resets are trying to confuse the situation. The option arm loan was very popular through 1Q07 - so take 40 months from that date, plus 3 months for them to go 90 days late and then and only will you see foreclosures start to level off.
To further drive home the point, Paul adds:
The reason why CFC, WM, WB, DSL and FED are all imploding is because the 2003 - 2004 pay option arm loans are all recasting and then going 90 days late. But all you need to know is pay option arm loans have a teaser payment that will last until the loan goes 110%-125% of original value and then the loan RECASTS to a fully amortizing loan. That is how a payment skyrockets - its simple math. Whereas payments can’t realistically double or triple with a simple ARM reset, most are capped every year - again the math is pretty simple.
Not that resets aren’t done. Check out this chart, courtesy of blogger Egor, who had posted a comment under another blog item here. Subprime resets may be ending, but the Option Arms have only just begun.