bankrate.com - Holden Lewis
March 9, 2006
Foreclosures will rise over the next few years, experts agree. While each foreclosure is traumatic
for the family that loses a house, the coming wave of defaults won't swamp the system.
The borrowers who are in the most danger have two strikes against them. First, they are (or will be)
underwater _ owing more than the house is worth. Second, they have adjustable-rate mortgages, or
ARMs, with low "teaser rates." Eventually, after anywhere from one month to five years, the ARM
enters its rate-adjustment period and the loan is reset with a higher rate.
Quite a few homeowners have these two strikes against them, and almost $200 billion in foreclosures
will result, says Christopher Cagan, director of research and analytics for First American Real
Estate Solutions.
Cagan prepared a 32-page report in February that measured the extent of the risk to the mortgage
market. It's not a financial-planning guide, but here's what consumers can take away from it: If you
have an ARM with a teaser rate of 2.5 percent or less, watch out, because the monthly payments could
skyrocket _ even double _ after the rate is reset. If, in addition, you owe more than the house is
worth, you could find yourself in serious trouble _ unable to refinance and unable to sell without a
loss.
Pretty common-sensical, really. That's why Larry Goldstone isn't all that worried. Goldstone,
president of Santa Fe, N.M.-based Thornburg Mortgage, says, "Generally speaking, I think people are
good people. They borrow money with the intention of paying it back."
When the business cycle moves down and people lose their jobs, more of them default, Goldstone says;
it doesn't matter much if the borrower gets a 30-year, fixed-rate mortgage or something
nontraditional, such as a payment-option ARM, in which the minimum payment doesn't cover that
month's interest.
David Greco, vice president of credit policy for MGIC, the largest insurer of mortgages, agrees that
the loan type doesn't matter much. A precarious mortgage, he says, is one "where the likelihood that
they'll be able to repay it is low, and I don't think there is anything that is inherently risky
about any loan programs that are out there today."
The risk comes from the possibility that the borrower and lender didn't accurately assess the
borrower's ability to repay, Greco says. One person might be able to handle a payment-option ARM
with aplomb, while another person might wilt under a 30-year fixed.
That's not how the federal government sees it. Regulators have proposed guidance _ essentially, a
set of strong suggestions _ urging lenders to be more careful with interest-only and payment-option
ARMs, especially in cases where the homeowner has little or no equity in the house or when the
borrower produced little or no documentation of income and assets.
Bankers worry that the guidance could result in fewer loans to deserving homebuyers. "The question
is, without these products, would we be better off? The answer is no," says David Herpers, chief
marketing officer for Amerisave, a lender that specializes in customers with damaged credit. "I
think, as a consumer, these emerging mortgage products are, overall, extremely beneficial."
Anthony LaGiglia, a financial planner with J.J. Burns & Co. in Melville, N.Y., isn't as sanguine
about nontraditional mortgages.
"When you look at interest-only mortgages, they were for a very select group of people _ a business
owner or a Wall Street person who gets a huge bonus every year," he says.
LaGiglia wonders what will happen to people who got low-rate ARMs when the rates enter the
adjustment period and rise dramatically. "I think people have no idea what can happen when the loans
reset at higher rates," he says. "People say, 'Oh, I'll refinance in the future.' But we've been at
30-year- and 40-year-low interest rates!"
That brings us back to Cagan, who wrote the paper for First American about reset sensitivity _ what
will happen when borrowers' payments spike after ARMs hit their adjustment periods. He says there
will be an extraordinarily high default rate among people who got teaser-rate option ARMs in 2004
and 2005, and who have less than 15 percent equity in their homes. But those people are a small part
of the overall pool of homeowners.
"Nationally, I think it will be a common cold, if you will," Cagan says, while acknowledging that it
will feel much worse to the people who lose their homes to foreclosure.
"The people who bought in 2003 or sooner ... they generally have enough equity that they're going to
do all right," Cagan says.
Related links:
Christopher Cagan's report for First American Real Estate Solutions on reset sensitivity:
www.loanperformance.com/infocenter/whitepaper/ FARES_resets_whitepaper_021406.pdf
Regulators' proposed guidance on nontraditional mortgages:
http://www.fdic.gov/news/news/press/2005/pr12805a.html
X X X
The benchmark 30-year fixed-rate mortgage rose 18 basis points to 6.45 percent, according to the
Bankrate.com national survey of large lenders. It was the biggest one-week rise since May 2004. It
is also the highest rate since Sept. 3, 2003, when the 30-year fixed rate was 6.47 percent. A basis
point is one-hundredth of 1 percentage point.
The mortgages in this week's survey had an average total of 0.34 discount and origination points.
One year ago, the mortgage index was 5.87 percent; four weeks ago, it was 6.32 percent.
(Reach Holden Lewis at hlewis(at)bankrate.com.)
(Distributed by Scripps Howard News Service. E-mail Holden Lewis at hlewis(at)bankrate.com)
Amerisave is one of the nation's leading and fastest-growing online mortgage companies, serving
customers in all 50 states and DC via its website, www.amerisave.com. Amerisave's mission is to provide the best
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