Eye of the Housing Hurricane
Posted by Doug Rice on Thu, Feb 11, 2010 @ 12:08 PM
After the first wall of the hurricane passes, there's a lull.
You're in the eye of the hurricane.
It may feel like it's over, but it's not. It just feels better because the wind stopped blowing for a minute. But when the second wall comes through, it could be just as bad as the first.
In housing, we weathered the storm - BARELY.
But that was just the first wall. The second wall is approaching and some us need to take cover.
Here's a chart that shows the impending mortgages that are going to reset in the next year or so.
As you can see, the second wall is coming. The first was the subprime loans, shown here in green. The second is the Option Adjustable Rate (Option ARM) loans, shown here in beige.
An Option ARM loan is often called a pick a payment loan as the borrower can decide what type of payment they want to make. Typically they can choose between a fixed rate of 15 or 30 years or interest only or a negative amortization minimum payment.
The first two options are basically regular loans, so while the option exists, no one chooses it. The second two are where the problems come in.
Interest only provides a lower payment as you aren't paying the prinicpal back. But eventually, you have to start paying back the principal and when that happens the loan payment resets potentially sharply upward.
If that wasn't enough of a problem, the other option is a negative amortization payment where not only have borrowers avoiding paying on the principal, they haven't even been paying the full interest due on the loan. So the balance due has been increasing.
For example, if you borrowed $400,000 on a house, paid less than the interest on the loan each month, you could owe $440,000 now years later, and that home might only be worth $250,000.
88 percent of Option ARMs originated between 2004 and 2007 are going to adjust higher between now and 2012. Those option ARM borrowers could see their housing bills go up as much as 63 percent, according to Fitch ratings.
With house values still struggling, when this next wall of payment resets hits, who's going to stay in their house with that kind of payment increase and little hope for an increase in value?
Some reports are citing almost 500,000 option ARM loans in California that will reset between now and 2012. With the state already struggling, people won't be able to make the higher payments, putting a huge block of inventory on the market, which will simply kill prices in the "Golden" State.
What's even worse is that the Federal Reserve is going to start raising interest rates to offset potential inflation. Many option ARM loans will go up with them so the payments just get bigger.
Why this matters to you
You may be thinking that this doesn't impact you because you aren't in one of these crazy loans. You may even think that some people deserve to lose their home because they acted recklessly and this should be a lesson to them.
Well, a lesson it is, but it does impact you too. Why?
Because another wave of housing foreclosures will impact the overall economy and will certainly impact residential real estate prices.
Going from "owning" a house to renting an apartment may not be the disaster of a lifetime, but no one does it, and then goes out and throws a party. And those watching it happen on TV and talking about it around the water cooler, don't throw parties either.
Consumer spending is almost 70% of the economy and if consumers are seeing people being thrown out of their homes, their own home price falling still, and the economy slowing again, it's likely they will tighten their purse strings. Which means the economy slows just that much faster.
We rarely get such a glimpse out the foggy windshield to the future. But in this case, it sure seems like the fog parted and it's pretty easy to see the road ahead.
The next wall of the hurricane is approaching. It's on the radar and we can see it. Batten down the hatches, and hold on. This could be a rough ride.
This is not a drill.